Do competition and efficiency lead to bank stability? Evidence from Bangladesh

Abstract

Abstract Financial deregulation after financial repression during 1980s and 1990s has stimulated a fierce competition among banks across the world. In pace with this, banking industry of Bangladesh is also experiencing an intense competition, since it is composed of a large number of banks. Considering this upsurge, our study aims to explore the impact of competition and efficiency on financial stability of Bangladeshi banks over 2009–2017. For exploring this nexus, we calculate Boone indicator and Z -score, construct banking efficiency index by principal component analysis, using bank-level data to measure competition, stability and efficiency, respectively, and analyze the impact of efficiency on financial stability at different levels of competition. We address the endogeneity of the estimation by employing two-step system GMM and different robustness checks. The findings of our study suggest a nonlinear competition–stability relationship, and though efficiency contributes to stability, the impact is moderated in the presence of competition. Our findings are robust to alternative measures of competition, stability and control variables, which could be useful for policy makers to formulate strategies and policies to maintain financial stability.