Competiton and bank stability in asean countries an empirical analysis

UNIVERSITY OF ECONOMICS HO CHI MINH CITY VIETNAM ERASMUS UNVERSITY ROTTERDAM INSTITUTE OF SOCIAL STUDIES THE NETHERLANDS VIETNAM – THE NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS COMPETITION AND BANK STABILITY IN ASEAN COUNTRIES: AN EMPIRICAL ANALYSIS BY Ms VU THI QUYNH MASTER OF ARTS IN DEVELOPMENT ECONOMICS HO CHI MINH CITY, Nov 2017 UNIVERSITY OF ECONOMICS HO CHI MINH CITY VIETNAM INSTITUTE OF SOCIAL STUDIES THE HAGUE THE NETHERLANDS VIETNAM - NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS COMPETITON AND BANK STABILITY IN ASEAN COUNTRIES: AN EMPIRICAL ANALYSIS A thesis submitted in partial fulfilment of the requirements for the degree of MASTER OF ARTS IN DEVELOPMENT ECONOMICS By Ms VU THI QUYNH Academic Supervisor: Dr NGUYEN THI THUY LINH HO CHI MINH CITY, Nov 2017 Declaration ―I certify the content of this dissertation has not already been submitted for any degree and is not being currently submitted to any other degrees I certify that, to the best of my knowledge, any assistance received in preparing this dissertation and all source used, have been recorded in this dissertation.‖ Signature Vu Thi Quynh Date: Nov 1st, 2017 iii Acknowledgement Foremost, I would sincerely thank Dr Nguyen Thi Thuy Linh, my supervisor, for her great support and advice in my thesis Furthermore, I would like to thank the Vietnam –Netherlands Program, especially professor Truong Dang Thuy and staffs for their great assistance in this thesis I also thank all my friends who always stand by my side with encouragement Lastly, I would like to thank my family for supporting not only in this thesis but also in my life iv Abstract Investigating the relationship between competition and bank stability has been at center of academic and policy issues, intensifying after occurrence of system banking crises over the last three decades The global trend towards consolidation in the financial industry, the banking sector in the ASEAN region experienced a dramatic shift from deregulation to regulation based on the experience of 1997 Asian Financial crisis Hence, this study examines the impact on bank stability of competition in ASEAN market by taking into account crisis periods Using unbalanced dataset from more 200 commercial banks across ASEAN countries over the period from 1995 to 2015, this study provides empirical evidence supporting the competition point of view that a non-linear or Ushaped nexus between competition and bank stability Banks were found to be highly volatile and lost capitalization during the 1997 Asian crisis, whereas the 2007-2008 global financial crisis stage did not directly affect Asian banks Besides, smaller banks in this region were more competitive than large banks over same period and they may contribute to improve financial soundness On the other hands, the findings also provide some recommendations for policymakers in ASEAN economics Key words: Competition, Stability, Market power, Concentration, Fragility v CONTENTS CHAPTER 1: Introduction 1.1 Problem statement 1.2 Scope of the study 1.3 Research objectives and research questions 1.4 Research methodology 1.5 Contributions and implications 1.6 Limitations and structure of the thesis CHAPTER 2: Literature review 2.1 Theoretical literature 2.1.1 Bank stability and competition 2.1.1.1 Charter value 2.1.1.2 The efficiency–stability debate 2.1.1.3 The concentration–contestability debate 11 2.1.1.4 Moral hazard and adverse selection problem 12 2.1.2 Main arguments about relationship between competition and bank stability 13 2.1.2.1 The traditional competition-instability view 13 2.1.2.2 The modern competition-stability view 15 2.1.2.3 The ambiguous 15 2.2 Empirical literature 16 2.3 Hypothesis construction 18 2.3.1 Competition and bank stability 18 2.3.2 Effect of financial crises on the competition and bank stability relationship 19 CHAPTER 3: Methodology 21 3.1 Model specifications 21 3.1.1 General specification 21 3.1.2 Specific regression equations 22 3.2 Description of the variables 23 3.2.1 Dependent variables 25 3.2.1.1 Bank Z-score 25 3.2.1.2 Capitalization ratio 27 3.2.1.3 Non-performing loan ratio 27 vi 3.2.2 Measures of bank competition 28 3.2.2.1 Lerner index 29 3.2.2.2 The Panzar-Rosse H-statistic: Non-Structural approach 30 3.2.2.3 The Herfindahl-Hirschman Index (HHI): Structural approach 32 3.2.3 Other control variables 33 3.2.3.1 The bank specific indicators 33 3.2.3.2 Regulatory indicators 34 3.2.3.3 Macro-economic indicators 35 3.2.3.4 Instrumental variables 37 3.3 Estimation method: Two-stage Least Square (2SLS) 38 3.4 Data sources 41 CHAPTER 4: Empirical analysis 43 4.1 Descriptive statistics and correlation structure 43 4.1.1 Description statistics 43 4.1.1.1 Competition and stability in ASEAN banks 43 4.1.1.2 Characteristics of ASEAN banks 44 4.1.1.3 Cross-country differences in bank regulatory policies 44 4.1.2 Competition and bank stability 46 4.1.3 The variable correlation 49 4.1.4 The first-stage regression 51 4.2 Results and discussion 53 4.2.1 The effect competition on stability 53 4.2.2 The impact of Asian crisis and global financial crisis on competition and bank stability relationship 60 4.2.3 The effect of Market Entry Conditions and Bank regulatory factor 63 4.2.4 Bank-level and country-level factors on competition-stability nexus 64 4.3 Robustness checks 65 CHAPTER 5: Conclusion 67 5.1 Conclusion 67 5.2 Policy implications 68 5.3 Limitations and suggestions for further research 69 REFERENCES 71 APPENDICES 75 vii LIST OF TABLES AND FIGURES Table-1: Summary some previous studies 20 Table-2: Summary of the variables used in the analysis 24 Table-3: ASEAN and country wise descriptive statistic of the variables 45 Table-4: Yearly average of H-statistic, Lerner index, HHI based on loan and CR3 based on loan for ASEAN-5 during 1990-2014 46 Table-5: Pearson pair wise correlation matrix of independent variables used in the analysis 50 Table-6: Variance Inflation Factor (VIF) 50 Table-7: The first-stage regression between instrumental variables and Z-score as a measure bank competition 51 Table-8: The comparison between FEM, REM and Pooled model The P-value shows the significant level at 1% and 5% 52 Table-9a The effect of competition measured by H-statistic, Lerner index and HHI on Zscore and equity ratio as measure of bank stability in ASEAN from 1995-2015 55 Table-9b: The effect of competition measured by H-statistic, Lerner index and HHI on NPL ratio as a measure of bank stability in ASEAN from 1995-2015 58 Table-10: The combined effect of bank competition and crises 61 Table-11: Summary findings 65 Fig 1: Log of Z-score, H statistic and Lerner index of ASEAN during 1995-2015 48 Fig 2: The correlation between LnZ-score, NPL ratio and Capital ratio of ASEAN banks from 1995-2015 49 Fig 3: ASEAN and other regions – Z-score and Concentration index 76 viii CHAPTER 1: Introduction 1.1 Problem statement The impact of competition on bank stability has been an issue of active disputation in both academic and policy circles for over three decades and especially since 1997-1998 Asian and the 2007-2008 global financial crises This debate was intensified by the deregulation of branches and activity restrictions in the United States during the late 1970s and early 1980s, lead to the international process of banking liberalization in both matured and emerging economies This makes more competition in the banking sector which large banks from advanced countries operating at low profit margin penetrate in developing countries with relatively high profit margin Meanwhile, some economists stated that these deregulation also positively impact on financial depth (Rice & Strahan, 2010), growth (Cetorelli & Gambera, 2001), income distribution (Beth at al., 2010b) and efficiency (Bertrand et al., 2007), and then led to the belief that the bank's fierce competition will promote a more efficient banking system Accordingly, competition is also seen as a pre-condition of efficient, innovative and developed financial system (Demirguc-Kunt & Peria, 2010; Weill, 2013; Apergis, Fafaliou, & Polemis, 2016) Unfortunately, there is a fact that, coupled with more competition through financial liberalization is the emergence of systemic banking crises in the last two decades of the 20th century and leading regulatory failures to bring the banking system in discipline have raised concerns among policy makers and academics regarding the subsequent effect of competition on bank stability in the banking system Consequently, the concern about the extent to which competition is responsible for these crises is still no consensus as to whether high or low competition leads to bank stability in the banking system In terms of banking sector in emerging countries, competition has been increasing due to the trend of penetration into the banking market of large foreign banks from advanced countries This prompted domestic banks to accelerate the consolidation process to protect their market power, leading to the appearance of "too big to fail" banks and the moral hazard incentives are more likely to exploit government aid (Berger & Mester, 2003) Furthermore, businesses depend significantly on banks for external funding to secure their operations (Adam, 2008) As a consequence, bank stability is a major concern for policy marker in the formulation of important policies In recent decades the relationship between competition and bank stability has been researched empirically focusing on both developed and developing nations Nevertheless, the findings of those studies ended up with conflicting experimental results keeping this link still a puzzle In addition, in order to resolve the consolidation logically, regulators need to consider how it could affect their overall goal of the financial system, which is to maximize social welfare This study assesses again this relationship, or further effect of competition on financial crisis on the competition-stability nexus that may be impaired by crisis Crisis may lead the banking sector to adopt divergent reform strategies, such as capital regulation, activity restriction, and consolidation which may change the market power or competition and risk taking behavior of the banks 1.2 Scope of the study Understand how competition can form the incentives of the credit institutions for risk taking is essential for a stable and efficient banking system that can finance timely profitable investment opportunities and remain sustainable economic growth By the above importance roles, few researches have focused on the impact of competition on the stability of banking system in the ASEAN context This study also contributes to the full implementation of this gap by using samples of 226 commercial banks from countries of ASEAN1 area These countries include Cambodia, Indonesia, Lao PDR, Malaysia, The Philippines, Thailand and Vietnam In terms of this study‘s territorial scope, the ASEAN region has seen an attractive sample providing a fertile laboratory to analyze this relationship, because its banking industry has been experienced liberalization via foreign bank penetration in early 1990s, followed by deregulation, regional economic integration, and tremendous consolidation in late 1990s as port 1997-98 Asian financial crisis strategies Specifically, the banking sector in this area has been sequentially and significantly affected from the Asian crisis in The Association of Southeast Asian Nations (ASEAN) is a regional organization comprising ten Southeast Asian nations that promotes intergovernmental cooperation and facilitates economic integration amongst its members Since its formation on August 8, 1967 by Indonesia, Malaysia, the Philippines, Singapore, and Thailand, membership has expanded to include Brunei Darussalam, Cambodia, Lao PDR, Myanmar, and Vietnam 213 214 215 216 217 218 219 220 221 222 223 224 225 226 Vietnam Vietnam Vietnam Vietnam Vietnam Vietnam Vietnam Vietnam Vietnam Vietnam Vietnam Vietnam Vietnam Vietnam VNM VNM VNM VNM VNM VNM VNM VNM VNM VNM VNM VNM VNM VNM ANZ Bank (Vietnam) Limited Shinhan Bank Vietnam National Citizen Commercial Joint Stock Bank Vietnam Thuong Tin Commercial Joint Stock Bank Nam A Commercial Joint Stock Bank Viet Capital Commercial Joint Stock Bank Standard Chartered Bank (Vietnam) Ltd Petrolimex Group Commercial Joint Stock Bank (The)-PG Bank Kien Long Commercial Joint Stock Bank Saigon Bank for Industry and Trade Bao Viet Commercial Joint Stock Bank Public Bank Vietnam Limited Mekong Development Joint Stock Commercial Bank Hong Leong Bank Vietnam Limited 81 Appendix 4: Exchange rates, Heritage Foundation index, Bank regulations Exchange rates on Dec 31 st, 2010 Cambodia Indonesia Lao PDR Malaysia Philippines Thailand Vietnam USD IDR LAK MYR PHP THB VND Financial Cambodia Indonesia freedom 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 50 50 50 50 50 50 70 70 70 70 50 50 50 50 50 50 50 50 50 50 50 50 50 30 30 30 30 30 30 30 30 40 40 40 40 40 40 50 60 60 Unit 0.000111 0.000124 0.319898 0.022775 0.033203 0.000051 USD USD USD USD USD USD USD Lao PDR Malaysia Philippines 10 10 10 10 10 10 10 10 10 10 30 20 20 20 20 20 20 20 20 20 82 50 50 50 50 50 50 30 30 30 30 30 30 40 40 40 50 50 50 50 60 60 50 50 50 50 50 50 50 50 50 50 30 50 50 50 50 50 50 50 50 50 60 Thailand Vietnam 50 50 50 50 50 50 50 50 50 50 50 50 50 50 60 70 70 70 70 70 60 30 30 30 30 30 30 30 30 30 30 30 30 30 30 30 30 30 30 30 30 30 Property Cambodia Indonesia rights 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 50 50 50 50 50 50 30 30 30 30 30 30 30 30 30 30 30 30 30 30 30 30 30 30 30 30 30 30 30 30 30 30 30 30 30 30 30 30 30 25 Activity restrictions Year Cambodia 2012 2007 2003 2000 Lao PDR Malaysia Philippines Thailand 10 10 10 10 10 10 10 10 10 10 10 10 10 10 15 20 15 15 15 15 Indonesia 14 Deposit insurance Year Cambodia Indonesia 2012 2007 2003 2000 Entry into banking Year Cambodia Indonesia 2012 2007 2003 2000 10 10 10 10 10 10 10 10 10 10 10 10 10 10 10 15 15 15 15 15 15 Thailand Vietnam 12 13 12 14 Lao PDR Malaysia Philippines Thailand Vietnam 1 1 0 Lao PDR Malaysia Philippines Thailand Vietnam 8 8 1 0 8 90 90 90 70 70 70 70 70 70 50 50 50 50 50 50 45 45 45 45 45 40 7 10 11 11 11 10 1 0 50 70 70 70 70 70 50 50 50 30 30 30 30 30 30 30 30 30 30 30 30 Lao PDR Malaysia Philippines 11 16 14 70 70 70 70 70 70 50 50 50 50 50 50 50 50 50 55 50 50 55 55 55 Vietnam 7 83 8 Capital requirements (Unit: %) Year Cambodia Indonesia 2012 2010 2009 2008 2007 2003 2000 Lao PDR Malaysia Philippines 8 8 20 8 8 8 8 84 10 10 10 10 10 10 10 Thailand Vietnam 8.5 8.5 8.5 8.5 8.5 8.5 8.5 Appendix 5A: The combined effect of LERNER as a bank competition and bank regulatory factor Variables LERNER L_ACT (1) Lnzscore (2) Lnzscore (3) Lnzscore (4) Lnzscore (5) ETA (6) ETA (7) ETA -0.669 (0.732) 0.0594 (0.0548) -1.312*** (0.395) -5.552*** (1.362) -3.796* (2.214) -8.901 (6.701) 1.219** (0.536) -5.297 (3.603) -34.98*** -6.808 (13.00) (19.10) L_DEPO 1.263*** (0.339) L_ENTRY 0.698*** (0.165) LOAN LLP COREV RGDPG INF ACRISIS GCRISIS -0.180*** (0.0472) 0.990*** (0.248) -9.729*** (2.870) -0.699** (0.272) 0.0226*** (0.00815) 0.000198 (0.00594) 0.280 (0.226) -0.141*** (0.0392) Observations 1,163 R-squared 0.202 Number 145 (9) NPL (10) NPL (11) NPL (12) NPL -6.702 (28.88) 0.418 (2.131) -28.18*** (7.889) 64.94** (28.29) -113.1 (88.55) 9.947*** (3.397) L_RECAP SIZE (8) ETA 19.45*** (6.810) 5.020*** (1.616) -0.174*** (0.0495) 1.142*** (0.261) -8.192*** (2.614) -0.638*** (0.238) 0.0294*** (0.00838) -0.00117 (0.00571) 0.493** (0.225) -0.0881* (0.0456) -0.0562 (0.0547) 0.934*** (0.284) -8.421*** (2.907) -0.484** (0.227) 0.0268*** (0.00666) 0.00296 (0.00536) 0.102 (0.173) -0.0143 (0.0453) 0.465* (0.261) -0.167*** (0.0466) 1.057*** (0.259) -10.23*** (3.104) -0.618** (0.251) 0.0156* (0.00822) 0.000318 (0.00578) 0.144 (0.219) -0.0753* (0.0398) 1,163 0.142 145 1,163 0.223 145 1,163 0.235 145 -2.589*** (0.499) 0.612 (2.647) -59.50** (24.37) -1.201 (0.810) 0.131 (0.101) 0.0379 (0.0424) 0.799 (1.900) -1.045** (0.530) -2.272*** (0.482) 2.147 (2.887) -52.62* (27.35) -0.603 (0.675) 0.127 (0.102) 0.0136 (0.0428) 2.154 (2.246) -0.372 (0.438) 1,185 0.168 146 1,185 0.102 146 -7.844** (3.381) -1.357** (0.535) 0.433 (3.065) -59.01** (26.36) 0.177 (0.903) 0.129 (0.104) 0.0678 (0.0491) -1.155 (1.685) 0.215 (0.512) 1.509 (2.253) -2.215*** (0.443) 1.036 (2.735) -63.75** (24.81) -0.834 (0.841) 0.0847 (0.104) 0.0546 (0.0439) -0.995 (1.767) -0.399 (0.477) -2.396*** (0.831) -16.90*** (5.070) 142.8*** (47.90) 2.531 (2.154) 0.148 (0.162) 0.225* (0.119) 3.356 (4.675) -3.028*** (0.873) -2.290** (0.889) -11.45*** (4.418) 153.2*** (52.27) 1.824 (2.026) 0.477*** (0.144) 0.306** (0.127) 1.317 (5.718) -2.803*** (0.554) -2.878*** (0.924) -21.90*** (4.814) 143.1*** (44.07) 1.536 (1.521) -0.0854 (0.138) 0.128 (0.110) 7.345 (4.605) -3.394*** (0.592) 13.28 (10.53) -2.526*** (0.841) -12.72*** (4.423) 130.7*** (48.92) 4.641* (2.481) 0.0322 (0.163) 0.206* (0.122) 0.922 (5.289) -2.204*** (0.710) 1,185 0.064 146 1,185 0.168 146 993 0.310 133 993 0.090 133 993 0.273 133 993 0.237 133 Robust standard errors in parentheses *** p|z| [95% Conf Interval] -+ -hstatistic | 4.544847 8648734 5.25 0.000 2.849726 6.239967 hstatistic2 | -5.086734 9792908 -5.19 0.000 -7.006109 -3.167359 size | -.2048473 046449 -4.41 0.000 -.2958856 -.1138089 loan | 7055748 2187819 3.23 0.001 2767702 1.134379 llp | -2.419952 2.612626 -0.93 0.354 -7.540605 2.700702 corev | -.0444397 0203807 -2.18 0.029 -.0843852 -.0044942 rgdpg | 0518936 0139363 3.72 0.000 0245789 0792082 inf | -.0040109 0046874 -0.86 0.392 -.013198 0051762 acrisis | 3522931 2015108 1.75 0.080 -.0426607 747247 gcrisis | -.0060544 040603 -0.15 0.881 -.0856348 073526 -Underidentification test (Kleibergen-Paap rk LM statistic): Chi-sq(3) P-val = 70.281 0.0000 -Weak identification test (Cragg-Donald Wald F statistic): (Kleibergen-Paap rk Wald F statistic): Stock-Yogo weak ID test critical values: 80.432 5% maximal IV relative bias 13.91 10% maximal IV relative bias 9.08 20% maximal IV relative bias 6.46 30% maximal IV relative bias Source: Stock-Yogo (2005) 55.899 5.39 10% maximal IV size 22.30 15% maximal IV size 12.83 20% maximal IV size 9.54 25% maximal IV size 7.80 Reproduced by permission NB: Critical values are for Cragg-Donald F statistic and i.i.d errors -Hansen J statistic (overidentification test of all instruments): Chi-sq(2) P-val = 13.894 0.0010 -endog- option: Endogeneity test of endogenous regressors: 11.810 Chi-sq(1) P-val = Regressors tested: 0.0006 hstatistic -Instrumented: hstatistic Included instruments: hstatistic2 size loan llp corev rgdpg inf acrisis gcrisis Excluded instruments: stock finfree right 95 ... towards a banking system of sustainable development and stability In brief, ASEAN banking market is distinctive by the following reasons Firstly, ASEAN s central banks pushed commercial banks towards... commercial banks established in 11 countries in Asia Main findings Competition increases stability as diversification across and within both interest and non-interest income generating activities of banks... concern of banking regulators and policy makers is to formulate policies that foster bank stability and reduce the risk of bank failure In analyzing the cause of fragility in banking industry,