Banking Sector Competition and its Impact on Banks’ Risk-Taking and Interest Margins in the Central and East European Countries

Abstract
This thesis provides empirical evidence on the degree of banking sector competition in the
Central and East European (CEE) countries and the impact of competition on banks’ risktaking
and interest margins. The thesis uses data on around 300 banks from 17 CEE countries
for the period 1999-2009, and employs a variety of estimation methodologies. The first
objective of the thesis is to measure the degree of banking sector competition in CEE
countries. Using the Panzar-Rosse approach, we found that the banking sectors of the CEE
countries have been characterized by monopoly behaviour. By distinguishing between the
non-EU and EU countries of the region, we found that banks operating in the non-EU
countries faced a lower degree of competition compared to banks operating in the EU
members of the region. The separate estimation for Kosovo indicated that the competitive
behaviour of banks operating in this country was consistent with monopolistic competition.
The second objective of the thesis is to estimate the impact of banking sector competition on
the degree of banks’ risk-taking. Using country-level Panzar-Rosse H-statistic estimates as a
measure of competition, for the overall sample, we found that competition enhances the
quality of the loan portfolio, thus providing evidence against the mainstream view on the
trade-off between competition and stability. However, for the non-EU countries of our
sample the impact of competition on banks’ risk-taking appeared positive, which implies that
more effective authorities are needed in these countries to oversee the banks’ behaviour when
competitive pressures increase. The third objective of the thesis is to estimate the impact of
banking sector competition on banks’ interest margins. The results suggest that competition
had a negative impact on net interest margins. The impact of competition in reducing the net
interest margins was stronger in the non-EU countries compared to the EU countries of the
sample. Overall, the results suggest that the banking sectors of the CEE countries are
characterized by low levels of competition, implying higher risk and larger interest margin.