financial stability report - Banka Qendrore e Republikës së Kosovës

Financial Stability Report
Number 3
In the absence of non-performing loans data for individual banks, the dependent variable in
our regression is composed by the share of loan-loss provisions to total loans (prov_loans).
The variable representing banking sector competition (Hstat) is the Panzar-Rosse H-
statistic which has been estimated in section 2. The model also contains several bankspecific
and country-specific control variables. The bank-specific control variables include:
total assets (ta) which are a measure of bank size; the share of non-interest income to total
assets (nonint) which is included to control for the structure of bank activity; the share of
equity to total assets (equity_ta) which is included to control for the risk-taking attitude of
the bank; and the Net Interest Margin (nim) which is included to control for the effect of
interest rates. The variables nonint, equity_ta and nim are specified in the first lags in
order to tackle the potential endogeneity with the dependent variable. The country specific
control variables in our model include: the market concentration ratio, i.e. the
Herfindahl_Hirschman Index for deposits (hhi_dep); the real GDP growth rate
(rgdpgrowth); the annual growth rate of the Consumer Price Index (cpi); the rule of law
index formulated by the World Bank (rule_law); and the Financial Freedom Index
formulated by the Heritage Foundation (fin_freed). The model also contains dummy
variables for each year (dv_year) and each country (dv_country).
The method chosen to run the regression is the Fixed Effects method. However, because a
pooled sample composed of several countries data is used, the inclusion of country dummies
is considered as necessary. Since the Fixed Effects method does not allow the inclusion of
country dummies, which are time invariant variables, the method used to run our
regression is the Fixed Effects Vector Decomposition method, which allows also the
inclusion of time-invariant variables. Nevertheless, for robustness test of our results, also
the simple fixed effects and the random effects (given that the Haussman Test does not
preclude the possibility of using it) are used.
8.4.2 Estimation results
The estimation results suggest a negative relationship between banking sector competition,
measured by the Panzar-Rosse H-statistic, and the level of risk in the banks loan portfolio,
measured by the share of loan-loss provisions to gross loans. In other words, the results
suggest that more competition leads to a better quality loan portfolio. This result is in line
with a number of empirical studies on this field, such as Schaeck and Čihák (2007),
Schaeck et al. (2006), Beck et al. (2003), Jayaratne and Strahan (1998). A great deal of the
theoretical literature on this field argues why competition should not lead to higher risktaking,
but the literature is quite limited in terms of the arguments why competition should
reduce banks’ risk-taking. However, in our view, the negative relationship between
competition and banks risk-taking may primarily be attributed to the fact that under more
competition depositors have more alternatives to place their deposits and as a result of this
they are more likely to “penalize” the banks with excessive risk-taking by moving their
deposits to safer banks. In addition, as argued by Chen (2007), when competition increases
banks may apply more screening since better quality borrowers may want to be better
screened in order to distinguish themselves from potentially weaker borrowers.
The regression controls also for the market concentration index, measured by the
Herfindahl-Hirschman Index (HHI) which is also argued to represent a measure of
competition. However, the impact of market concentration on bank risk resulted to be
statistically insignificant. The inclusion or not of the HHI into the regression does not
appear to affect neither the sign not the statistical significance of the H-statistic, thus
providing support to the view of Claessens and Laeven (2003) who claimed that
concentration and competition describe different features of a banking market, and
therefore they have independent effects on the stability of the banking system.
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