Does bank competition and diversification lead to greater stability? Evidence from emerging markets

Abstract

This paper investigates how the level of competition affects diversification and stability using a sample of 978 banks in 55 emerging and developing countries over an eight year period 2000–2007. We shed further light on the competition-stability nexus by examining the complex interaction between three key variables: the degree of bank market power, diversification and stability. The core finding is that competition increases stability as diversification across and within both interest and non-interest income generating activities of banks increases. Our analysis identifies revenue diversification as a channel through which competition affects bank insolvency risk in emerging countries. The results are robust to an array of controls including alternative methodology, variable specifications and the regulatory environments that banks operate in.