Does market structure matter on banks' profitability and stability? Emerging versus advanced economies

Abstract

We investigate the effects of market power, banking and bank-environment activities on profitability and stability (risk and returns) for a total of 1929 banks in 40 emerging and advanced economies over the sample period of 1999-2008. The model developed in this paper incorporates the traditional structure-conduct-performance (SCP) and the relative-market-power (RMP) hypotheses with the view to assessing the extent to which the bank performance can be attributed to non-competitive market conditions and pricing behaviour. The key findings are as follows; i) a greater market power leads to higher bank performance being biased toward the RMP hypothesis in advanced economies; ii) more concentrated banking systems in advanced economies may be more vulnerable to financial instability; iii) Neither of the hypotheses seems to be supported for the returns in the emerging banking sector; and iv) higher interest rate spreads increase profitability and stability for both types of economies, however, for emerging banks this seems to be one of the key elements to increase their profitability raising concerns on economies. Other interesting findings include that off-balance-sheet activities appear to present banks with a trade-off between risk and returns in advanced economies, and the effects of bank age, bank ownership status and regulation on risk and returns, depend on market power.