Linking bank competition, financial stability, and economic growth
Abstract
This paper investigates the effect of bank competition and financial stability on economic growth by examining panel-data from 38 European countries over 2001 to 2017. Bank competition is measured with the Boone indicator, and bank stability with Z-scores and non-performing loan ratios, all at the country level. This study employs a fixed-effect estimator, as well as a system generalized method of moment (GMM) estimator to control unobserved heterogeneity, endogeneity, the dynamic effect of economic growth, and reverse causality in its estimation. Results show that bank stability significantly contributes to economic growth in Europe. Economic growth falls during crisis periods (both the global financial crisis and the local banking crisis), highlighting the importance of a resilient banking system during crisis periods. Moreover, empirical outcomes show that lower banking competition supports economic growth and increases financial stability. This study provides a framework for banks and regulators to boost economic growth through the channel of banking stability.
Keyword : bank stability, bank competition, economic growth, system GMM, global financial crisis, local banking crisis, bank Z-score, non-performing loans, channelling effect
How to Cite
Ijaz, S., Hassan, A., Tarazi, A., & Fraz, A. (2020). Linking bank competition, financial stability, and economic growth. Journal of Business Economics and Management, 21(1), 200-221. https://doi.org/10.3846/jbem.2020.11761
This work is licensed under a Creative Commons Attribution 4.0 International License.
References
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Diallo, B., & Koch, W. (2018). Bank concentration and Schumpeterian growth: Theory and international evidence. Review of Economics and Statistics, 100(3), 489–501. https://doi.org/10.1162/rest_a_00679
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Amidu, M., & Wilson, J. O. S. (2014). Competition in African Banking: Do globalization and institutional quality matter? 31 p. https://doi.org/10.2139/ssrn.2399050
Arellano, M., & Bond, S. (1991). Some tests of specification for panel data: Monte Carlo evidence and an application to employment equations. The Review of Economic Studies, 58(2), 277–297. https://doi.org/10.2307/2297968
Arellano, M., & Bover, O. (1995). Another look at the instrumental variable estimation of error-components models. Journal of Econometrics, 68(1), 29–51. https://doi.org/10.1016/0304-4076(94)01642-D
Baron, R. M., & Kenny, D. A. (1986). The moderator-mediator variable distinction in social psychological research: Conceptual, strategic, and statistical considerations. Journal of Personality and Social Psychology, 51(6), 1173–1182. https://doi.org/10.1037/0022-3514.51.6.1173
Blundell, R., & Bond, S. (1998). Initial conditions and moment restrictions in dynamic panel data models. Journal of Econometrics, 87(1), 115–143. https://doi.org/10.1016/S0304-4076(98)00009-8
Boone, J. (2008). A new way to measure competition. The Economic Journal, 118(531), 1245–1261. https://doi.org/10.1111/j.1468-0297.2008.02168.x
Boyd, J. H., & De Nicolo, G. (2005). The theory of bank risk taking and competition revisited. The Journal of Finance, 60(3), 1329–1343. https://doi.org/10.1111/j.1540-6261.2005.00763.x
Caggiano, G., & Calice, P. (2016). Bank competition, financial dependence, and economic growth in the Gulf Cooperation Council (World Bank Group, Policy Research Working Paper. 7687). The World Bank, Washington, D.C. https://doi.org/10.1596/1813-9450-7687
Carletti, E., Hartmann, P., & Spagnolo, G. (2002). Implications of the bank merger wave for competition and stability, in risk measurement and systemic risk. In Proceedings of the Third Joint Central Bank Research Conference held at the Bank for International Settlement, Basel (pp. 38–50).
Cave, J., Chaudhuri, K., & Kumbhakar, S. C. (2019). Do banking sector and stock market development matter for economic growth? Empirical Economics, 1–23. https://doi.org/10.1007/s00181-019-01692-7
Cetorelli, N., & Gambera, M. (2001). Banking market structure, financial dependence and growth: International evidence from industry data. The Journal of Finance, 56(2), 617–648. https://doi.org/10.1111/0022-1082.00339
Claessens, S. (2009). Competition in the financial sector: overview of competition policies. The World Bank Research Observer, 24(1), 83–118. https://doi.org/10.1093/wbro/lkp004
Claessens, S., & Laeven, L. (2005). Financial dependence, banking sector competition, and economic growth. Journal of the European Economic Association, 3(1), 179–207. https://doi.org/10.1162/1542476053295322
Coccorese, P. (2008). Bank competition and regional differences. Economics Letters, 101(1), 13–16. https://doi.org/10.1016/j.econlet.2008.03.019
Cole, R. A., Moshirian, F., & Wu, Q. (2008). Bank stock returns and economic growth. Journal of Banking & Finance, 32(6), 995–1007. https://doi.org/10.1016/S0378-4266(02)00408-9
Craig, B., & Santos, J. C. (1997). The risk effects of bank acquisitions. Federal Reserve Bank of Cleveland Economic Review, 33, 25–35.
Craigwell, R., Downes, D., & Howard, M. (2001). The finance-growth nexus: a multivariate VAR analysis of a small open economy. Savings and Development, 25(2), 209–223. www.jstor.org/stable/25830760
Creel, J., Hubert, P., & Labondance, F. (2015). Financial stability and economic performance. Economic Modelling, 48, 25-40. https://doi.org/10.1016/j.econmod.2014.10.025
Darlington, R. B., & Hayes, A. F. (2016). Regression analysis and linear models: Concepts, applications, and implementation. Guilford Publications.
De Guevara, J. F., & Maudos, J. (2011). Banking competition and economic growth: cross-country evidence. The European Journal of Finance, 17(8), 739–764. https://doi.org/10.1080/1351847X.2011.554300
De Guevara, J. F., Maudos, J., & Perez, F. (2005). Market power in European banking sectors. Journal of Financial Services Research, 27(2), 109–137. https://doi.org/10.1007/s10693-005-6665-z
Dell’Ariccia, G., Detragiache, E., & Rajan, R. (2008). The real effect of banking crises. Journal of Financial Intermediation, 17(1), 89–112. https://doi.org/10.1016/j.jfi.2007.06.001
Dell’Ariccia, G., Friedman, E., & Marquez, R. (1999). Adverse selection as a barrier to entry in the banking industry. The RAND Journal of Economics, 30(3), 515–534. https://www.jstor.org/stable/2556061
Diallo, B., & Koch, W. (2018). Bank concentration and Schumpeterian growth: Theory and international evidence. Review of Economics and Statistics, 100(3), 489–501. https://doi.org/10.1162/rest_a_00679
Fedaseyeu, V., Linck, J. S., & Wagner, H. F. (2018). Do qualifications matter? New evidence on board functions and director compensation. Journal of Corporate Finance, 48, 816–839. https://doi.org/10.1016/j.jcorpfin.2017.12.009
Fernandez, A. I., González, F., & Suárez, N. (2013). The real effect of banking crises: Finance or asset allocation effects? Some international evidence. Journal of Banking & Finance, 37(7), 2419–2433. https://doi.org/10.1016/j.jbankfin.2013.02.012
Fernandez, A. I., González, F., & Suárez, N. (2016). Banking stability, competition, and economic volatility. Journal of Financial Stability, 22, 101–120. https://doi.org/10.1016/j.jfs.2016.01.005
Ferris, S. P., Javakhadze, D., & Rajkovic, T. (2017). CEO social capital, risk-taking, and corporate policies. Journal of Corporate Finance, 47, 46–71. https://doi.org/10.1016/j.jcorpfin.2017.09.003
Fu, X. M., Lin, Y. R., & Molyneux, P. (2014). Bank competition and financial stability in Asia Pacific. Journal of Banking & Finance, 38, 64–77. https://doi.org/10.1016/j.jbankfin.2013.09.012
Gaffeo, E., & Mazzocchi, R. (2014). Competition in the banking sector and economic growth: Panel-based international evidence (DEM Discussion Paper, No. 02/2014). University of Trento. Trento. https://doi.org/10.2139/ssrn.2416379
Gurley, J. G., & Shaw, E. S. (1955). Financial aspects of economic development. The American Economic Review, 45(4), 515–538. https://www.jstor.org/stable/1811632
Hamada, K., Kaneko, A., & Yanagihara, M. (2018). Oligopolistic competition in the banking market and economic growth. Economic Modelling, 68, 239–248. https://doi.org/10.1016/j.econmod.2017.07.017
Hoggarth, G., Reis, R., & Saporta, V. (2002). Costs of banking system instability: some empirical evidence. Journal of Banking & Finance, 26(5), 825–855. https://doi.org/10.1016/S0378-4266(01)00268-0
Jayakumar, M., Pradhan, R. P., Dash, S., Maradana, R. P., & Gaurav, K. (2018). Banking competition, banking stability, and economic growth: Are feedback effects at work? Journal of Economics and Business, 96, 15–41. https://doi.org/10.1016/j.jeconbus.2017.12.004
Jokipii, T., & Monnin, P. (2013). The impact of banking sector stability on the real economy. Journal of International Money and Finance, 32, 1–16. https://doi.org/10.1016/j.jimonfin.2012.02.008
Keeley, M. (1990). Deposit insurance, risk, and market power in banking. The American Economic Review, 80(5), 1183–1200. Retrieved from www.jstor.org/stable/2006769
Laeven, L., & Valencia, F. (2012). Systemic banking crises database: An update (WP/12/1630). https://doi.org/10.5089/9781475505054.001
Lane, P. R., & Milesi-Ferretti, G. M. (2007). The external wealth of nations mark II: Revised and extended estimates of foreign assets and liabilities, 1970–2004. Journal of International Economics, 73(2), 223–250. https://doi.org/10.1016/j.jinteco.2007.02.003
Levine, R. (2005). Finance and growth: theory and evidence. Handbook of Economic Growth, 1, 865–934. https://doi.org/10.1016/S1574-0684(05)01012-9
McKinnon, R. I. (1973). Money and capital in economic development. Washington, D.C.: Brookings Institution.
Mitchener, K. J., & Wheelock, D. C. (2013). Does the structure of banking markets affect economic growth? Evidence from U.S. state banking markets. Explorations in Economic History, 50(2), 161–178. https://doi.org/10.1016/j.eeh.2012.09.004
Moshirian, F., & Wu, Q. (2012). Banking industry volatility and economic growth. Research in International Business and Finance, 26(3), 428–442. https://doi.org/10.1016/j.ribaf.2012.01.004
Ngare, E., Nyamongo, E. M., & Misati, R. N. (2014). Stock market development and economic growth in Africa. Journal of Economics and Business, 74, 24–39. https://doi.org/10.1016/j.jeconbus.2008.05.001
Owusu, E. L., & Odhiambo, N. M. (2014). Financial liberalisation and economic growth in Nigeria: An ARDL-bounds testing approach. Journal of Economic Policy Reform, 17(2), 164–177. https://doi.org/10.1080/17487870.2013.787803
Pradhan, R. P., Arvin, M. B., Bahmani, S., Hall, J. H., & Norman, N. R. (2017). Finance and growth: Evidence from the ARF countries. The Quarterly Review of Economics and Finance, 66, 136–148. https://doi.org/10.1016/j.qref.2017.01.011
Pradhan, R. P., Arvin, M. B., Nair, M., & Bennett, S. E. (2019). Inter-linkages between competition and stabilisation policies in the banking sector and stock market development in Europe. Applied Economics, 51(39), 4313–4324. https://doi.org/10.1080/00036846.2019.1591603
Preacher, K. J., & Hayes, A. F. (2004). SPSS and SAS procedures for estimating indirect effects in simple mediation models. Behavior Research Methods, Instruments & Computers, 36(4), 717–731. https://doi.org/10.3758/BF03206553
Rakshit, B., & Bardhan, S. (2019). Does bank competition promote economic growth? Empirical evidence from selected South Asian countries. South Asian Journal of Business Studies, 8(2), 201–223. https://doi.org/10.1108/SAJBS-07-2018-0079
Roodman, D. (2009). How to do xtabond2: An introduction to difference and system GMM in Stata. The Stata Journal, 9(1), 86–136. https://doi.org/10.1177/1536867X0900900106
Rungtusanatham, M., Miller, J. W., & Boyer, K. K. (2014). Theorizing, testing, and concluding for mediation in SCM research: Tutorial and procedural recommendations. Journal of Operations Management, 32(3), 99–113. https://doi.org/10.1016/j.jom.2014.01.002
Schnitzer, M. (1999). On the role of bank competition for corporate finance and corporate control in transition economies. Journal of Institutional and Theoretical Economics, 155, 22–46. https://doi.org/10.1016/j.qref.2015.06.008
Schumpeter, J. A. (1912). Theorie der Wirtschaftlichen Entwicklung. Leipzig: Dunker & Humblot. [The theory of economic development. Translated by Redvers Opie. Cambridge, MA: Harvard University Press, 1934].
Semrau, T., & Sigmund, S. (2012). Networking ability and the financial performance of new ventures: A mediation analysis among younger and more mature firms. Strategic Entrepreneurship Journal, 6(4), 335–354. https://doi.org/10.1002/sej.1146
Soedarmono, W., Machrouh, F., & Tarazi, A. (2011). Bank market power, economic growth and financial stability: Evidence from Asian banks. Journal of Asian Economics, 22(6), 460–470. https://doi.org/10.1016/j.asieco.2011.08.003
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