Banking Sector Competition: A Roadmap for Financial Stability?

Abstract

The article examines the issues of competition in the banking sector in the context of the post-crisis policy of international banking regulation. The overarching objective of this policy is to achieve financial stability and minimize the risk of future financial crises. An understanding of the new phenomena of competition in the international banking sector and their interrelation with the issues of financial stability should facilitate the strengthening of market discipline in the banking sector and enhance the long-term potential of credit institutions as reliable providers of market liquidity. Conversely, achieving equilibrium between banks’ compliance to post-crisis regulatory standards and their capacity to establish competitive advantages will not only enhance their resilience in the context of an unstable external environment but will also represent an effective strategy for mitigating systemic risks and systemic stress.

A synthesis of studies on the impact of banking sector competition on financial stability (Competitive-fragility hypothesis and Competitive-stability hypothesis) reveals a contradictory effect due to the multifaceted nature of competition. Consequently, there is no definitive assessment of competition with regard to ensuring stress resilience in the banking sector. Increased competition can both contribute to reducing the vulnerability of banking activities to various risks and challenges and become a source of instability. Guided by the primacy of balanced development of the banking sector, we propose to supplement the toolkit of international banking regulation with a quantitative indicator of competition assessment based on the risks of banking activities, taking into account the standards and recommendations of Basel III.