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The relationship between competition and risk-taking behaviour of Indian banks

Sanjukta Sarkar (Indira Gandhi National Open University, New Delhi, India)
Rudra Sensarma (Department of Economics, Indian Institute of Management Kozhikode, Kozhikode, India)

Journal of Financial Economic Policy

ISSN: 1757-6385

Article publication date: 4 April 2016

1158

Abstract

Purpose

Under the traditional franchise value paradigm, competition in banking markets is considered to be risk enhancing because of its tendency to raise interest rates on deposits. Taking a contrarian view, Boyd and De Nicolo (2005) have argued that competition in the loan market can lead to lower interest rates and hence reduce bank risk-taking. Following these contradictory theoretical results, the empirical evidence on the relationship between risk and competition in banking has also been mixed. This paper analyses the competition–stability relationship for the Indian banking sector for the period 1999-2000 to 2012-2013.

Design/methodology/approach

Banking competition is measured using structural measures of concentration, namely, five-bank concentration ratios and the Herfindahl-Hirschman Index as well as a non-structural measure of competition – the Panzar-Rosse H-Statistic. Panel regression methods are used to estimate the relationships.

Findings

Our results show that while concentration leads to lower levels of default, market and asset risks, it exacerbates the levels of capital and liquidity risks.

Practical implications

These results have interesting implications for banking sector policy in emerging economies. For instance, any strategy on entry of new banks has to be carefully coordinated with supervisory efforts and macro-prudential policy to derive the benefits of greater competition in the banking industry.

Originality/value

This is the first paper that analyses the competition – stability relationship using a large number of alternative measures for the banking sector, an emerging economy.

Keywords

Acknowledgements

The authors gratefully acknowledge comments received at the 2nd Pan IIM World Management Conference held at the Indian Institute of Management Kozhikode during November 5-8, 2014, where a previous version of this paper was presented.

Citation

Sarkar, S. and Sensarma, R. (2016), "The relationship between competition and risk-taking behaviour of Indian banks", Journal of Financial Economic Policy, Vol. 8 No. 1, pp. 95-119. https://doi.org/10.1108/JFEP-05-2015-0030

Publisher

:

Emerald Group Publishing Limited

Copyright © 2016, Emerald Group Publishing Limited

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