How Does Bank Competition Affect Solvency, Liquidity and Credit Risk? Evidence from the MENA Countries

IMF Working Papers, September 29, 2015

Source details

Canonical URL: How Does Bank Competition Affect Solvency, Liquidity and Credit Risk? Evidence from the MENA Countries

Price competition has a positive effect on bank liquidity by inducing self-discipline incentives on banks for the choice of bank funding sources and for the holding of liquid assets.
Price competition may have a potentially negative impact on bank solvency and on the credit quality of the loan portfolio.
More competitive banks may be less solvent if the potential increase in the equity base—due to capital adjustments—is not large enough to compensate for the reduction in bank profitability.
Banks subject to stronger competitive pressures may have a higher rate of nonperforming loans if the increase in the risk-taking incentives from the lender’s side overcomes the decrease in the credit risk from the borrower’s side.
Country-specific policies for market entry conditions—and for bank regulation and supervision—may significantly affect the sign and the size of the relationship between competition and bank stability.

Liquidity channel:
- Price competition → greater self-discipline on funding choices → higher holdings of liquid assets → improved bank liquidity.
Solvency channel:
- Price competition → reduced bank profitability → possible need for capital adjustments.
- If capital adjustments do not sufficiently increase the equity base, solvency may decline.
Credit-risk channel:
- Competition affects lender risk-taking incentives and borrower credit risk.
- Net effect on nonperforming loans depends on whether lender-side risk-taking increases more than borrower-side credit risk decreases.

Improve market contestability to shape competitive dynamics positively.
Increase the quality and independence of prudential supervision to mitigate potential adverse effects of competition on solvency and credit risk.
Tailor country-specific policies for market entry conditions and for bank regulation and supervision to influence the sign and magnitude of competition–stability relationships.