Competition, Efficiency, and Stability in Banking

Posted by D. Daniel Sokol

Klaus Schaeck, University of Wales – Bangor Business School and Martin Cihak, World Bank offer thoughts on Competition, Efficiency, and Stability in Banking

ABSTRACT: We examine the effect of competition on banking stability using a new measure of competition based on the reallocation of profits from inefficient banks to efficient ones (Boone, 2008). Examining a sample of European banks, we show that this measure does capture competition, that competition is stability-enhancing, and that the stability-enhancing effect of competition is greater for healthy banks than for fragile ones. Our results suggest that efficiency is the conduit through which competition contributes to stability and that regulators must condition policy on the health of existing banks.