The relationship between bank competition and financial stability: a case study of the Mexican banking industry
| Autor | Raúl Osvaldo Fernández - Jesús G. Garza-García |
| Cargo | Financial Researcher, Directorate of Financial Stability, Banco de México - Chief Mexico Economist, Itaú BBA |
| Páginas | 103-120 |
Ensayos Revista de Economía–Volumen XXXIV, No.1, mayo 2015, pp. 103-120
The relationship between bank competition and financial
stability: a case study of the Mexican banking industry
Raúl Osvaldo Fernández
Jesús G. Garza-García
Fecha de recepción: 22 VII 2013 Fecha de aceptación: 19 I 2015
Abstract
This pap er tests both the competition-fragility and competition-stability
hypotheses in the Me xican banking sector for the period 2001-2008. In order
to account for the degree of competition we use Lerner index, and the Z-
index and the ratio of non-performing loans over total loans as proxies of
financial stability and bank portfolio risks respectively. The main results
indicate there is support for both hypotheses. However, the benefits o f greater
competition on the overall stability of the system outweigh the increases in
bank portfolio risks.
JEL Classification: D4; G15; G21; L11; N2.
Keywords: Financial Stability, Lerner index, Bank Competition, Mexican
Banking Sector, Generalised Method of Moments (GMM).
Resumen
Este artículo analiza las hipótesis de competencia-fragilidad y competencia-
estabilidad en el sistema b ancario mexicano, para el periodo 2001-2008. P ara
medir el nivel de competencia, se emplea el índice de Lerner y el índice -Z,
así como la razón de créditos morosos entre créditos totales como proxies de
estabilidad financiera y riesgo de portafolio, respectivamente. Los resultados
indican que existen argumentos para sustentar ambos modelos. Sin embargo,
los beneficios de un mayor nivel de estabilidad financiera en el sistema tiene n
más peso que el incremento en los riesgos de portafolio.
Financial Researcher, Directorate of Financial Stability, Banco de México. Address: Ave.
5 de mayo # 1 piso 1, Del. Cuauhtémoc, México, D.F. Phone: + 52 (55)52372000, ext.
3252. E-mail: rfernandez@banxico.org.mx.
Corresponding author: Chief Mexico Economist, Itaú BBA. Address: Avenida Santa Fé
462, Piso 14, Col. Santa Fé, Del. Cuajimalpa, CP. 05438, Mexico City. Phone: +52
(55)41618908. E-mail address: jesus.garza@itaubba.com.
Ensayos Revista de Economía
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Clasificación JEL: D4; G15; G21; L11; N2.
Palabras Clave: estabilidad financiera, índice de Lerner, competencia
bancaria, sector bancario mexicano, método generalizado de momentos
(GMM ).
Introduction
There have been recent debates on the relationship between banking
competition and the overall stability of the financial system. As such, two
opposing views have emerged: competition-fragility and competition-
stability. The competition-fragility view suggests a negative relationship
between bank competition and financial stability, while the competition-
stability view proposes a positive relationship. Many authors have tested
these relationship s in various co untries and regions and have obtained
contrasting results. However, as far as we k now, no such study has been done
for the Mexican banking industry.
Beck (2008) explains that similarly to other non-financial industries,
competition in the banking sector is desirable since it often generates a more
efficient market, with all the benefits that come along (e.g. efficient
allocation of resources and b etter prices for consumers). However, there are
theories suggesti ng that more co mpetitive banking sectors may increase the
instability of the financial system. As greater banking competition decreases
bank profit margins, banks are encouraged to take on riskier investments in
order to boost their profits, supporting the competition-fragi lity view (Berger
et al., 2008). However, Boyd and De Nicolo (2005) argue that greater bank
concentration in the lending markets may increase instability through
increased risks, since higher interest rates charged on consumers may make it
harder for them to rep ay their loans, thus supporting the competition-stability
view. It is therefore interesti ng to test both hypotheses and find whether bank
competition is desirable in order to increase financial stability.
More spec ifically, it is interesting to test these relationships in the Mexican
banking industry. This industry has recently experienced a period of banking
consolidation and a reduction in competition, whilst at the same recovered
from the recent international financial crisis. T o the best of our knowledge no
country specific studies have been done with regards to the Mexi can banking
industry.
This paper is divided into six sections : Section 1 addresses the background of
the Mexican banking industry, Section 2 presents the li terature review on the
competition-stability relationships, Section 3 introduces the data and
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