Research on the Mechanism and Conditions of the System Stability of the
Banking under the Competition Effect
Jin-feng She1, Mei-xia Li2
1,2
School of Business of East China University of Science and Technology, Shanghai, China
(jfshe@ecust.edu.cn, limeixia1102@163.com)
Abstract - Along with the economic globalization and
financial liberalization, bank competition has impacted on
the banking stability profoundly. But the effect of bank
competition on individual bank stability and the whole
banking system stability is different. Based on the related
articles at home and abroad and the analysis of the
competition and stability of the banking in China, this
paper thought that it is uncertain whether bank
competition is good for the development of the bank
individual stability. However it is beneficial to the system
stability of the banking. This paper analyzed the
mechanism of the stability of the system and conditions
under the effect of banking competition by use of the
system self-organization theory and the survival of the
fittest theory.
Keywords - Bank competition, stability of the banking
system, stability mechanism, stability conditions
I. INTRODUCTION
Financial is the core of the modern economy, bank
was regarded as the principal part of finical activities. Its
steady development has great impact on harmonious and
sustainable development of social economic system.
With the economic globalization and financial
liberalization, the banks face more and more
competition, which produces far-reaching effect on
banking stability. What kind of impact does competition
in the banking sector have on banking stability? And
how it affects banking stability? These issues become
the hotspot of theoretical research and practical research
at home and abroad in recent years, but the conclusions
are not consistent.
This paper attempts to summarize the situations of
competitive effects on the stability of the banking
system by studying the related literature and analyzing
the competition and stability of the banking industry in
China. Furthermore, the system self-organization theory
and the survival of the fittest theory are used to analyze
the mechanism and conditions of the banking system
stability under the effect of banking competition.
II. LITERATURE REVIEWS
There are two different views about the effect of
bank competition on bank stability. Some early scholars
held the view that the banking competition was not
benefit to the stability of the banking industry. Such as,
Kelley (1990), Alien and Gale (2000a) considered that
fiercer competition among banks would erode the
incumbent monopoly rent and reduce the franchise
value. As banks franchise values erode, this may create
incentives to gamble and may lead to a shift towards
riskier activities [1][2]. Shaffer, Sherrill (1998) found a
phenomenon in the United States that the borrower's
overall quality was declining in the financial market
with the increasing number of the banks. The reason is
that, when there is fiercer competition among banks, it
would affect selecting criterion to bank lenders. If the
applicants are refused by one or more banks, they can
continue to apply for other banks. If the competition
between banks is intense, and there is no cost or low
cost for the lender loan application frequently, the low
quality enterprises to obtain loans will be improved [3].
Hellman, Murdoek Stiglitz(2000) found that financial
liberalization in United States and Japan reduced the
enter doorsill for banking industry, relaxed the control
of interest rate, and increased market competition of
deposit through the establishment of deposit dynamic
competition models. Therefore, banks tried to expand
sources of funding by raising deposit rates. Raising the
deposit interest rate means an increase in the cost of
funds. It would erode the banks' profits, reduce the
franchise value, and encourage banks to take more risk
[4]
. Cordella and Yeyati (2002) studied the bank
competition effect on supervisory, they considered that
banking competition reduced the investment for bank
supervise [5]. In the further proof, Repullo(2003) thought
the key factor, which make the competition encourage
banks to take excessive risk, is that the risk revenue was
mainly to bank shareholders, while the bear of loss was
mainly shouldered by government or depositors[6].
However there are more and more researchers get
the conclusion that banking competition is conducive to
the stability of the banking through empirical research in
recent years. In this view, they thought that a high
concentration banks would get political asylum, accept
the high lending rates from customers, and lead to more
adverse selection and moral hazard. Such as,
Boyd(2006) considered that the probability of bank
failure was positively correlated with the degree of
concentration, the loan-to-assets ratio had a significant
negative correlation with the degree of concentration,
and there was a significant positive correlation between
bank profits and the degree of concentration and a tradeoff correlation between bank competition and financial
stability[7]. Schaeck(2009) concluded that the highly
competitive banking system was not prone to banking
crises by studying on the relationship between bank
competition and financial stability form the 38 countries
from 1980 to 2003, including Japan, China, the United
States, Germany, and so on[8]. Guo Jun (2003) analyzed
the relationship between banking competition and
stability from the functional point, and concluded that
the instability of the banking system was caused by the
bank's functional conflict, while the competition within
the banking can effectively cut the bank's functions
conflict, improve the matching function and effectively
enhance the stability of banking system. Zou Peng-fei
(2011), by studying the impact of bank competition on
bank stability from an empirical point of view, obtained
the results that as the credit market competition degree
rise, the bank's bad loan rate reduced ceaselessly, the
capital adequacy improved continuously, and the overall
stability enhanced constantly[9].
There are two reasons why the impact of
competition on bank stability has different conclusions
in the existing literature. First of all, the different
literature has different research object, some literature is
based on the bank individuals, and the others is based on
the whole banking industry. Second, the financial
environment of different research object is not the same,
different countries in different period has different
financial environment, in which impact of bank
competition on stability is different. Therefore, it is
difficult to obtain a unified conclusion.
III. ANALYSIS TO COMPETITION AND
TableI
THE ASSETS SCAE AND MARKET STRUCTURE OF CHINA'S
BANKING FORM 2001TO 2008
The
share of
Sharehol
ding
commer
cial
banks in
total
assets (
%)
The share
of city
commerci
al banks
in total
assets
(%)
The
share of
other
financial
institutio
ns in
total
assets (
%)
Year
Total
banking
assets（
billion
yuan)
2001
158418.1
77.1
-
-
-
2002
236643.8
75.0
-
-
-
2003
276583.8
54.9
13.8
5.3
25.9
2004
315989.8
53.6
14.9
5.4
26.2
2005
374696.9
52.4
15.5
5.4
26.6
2006
439499.7
51.3
16.2
5.9
26.6
2007
525982.5
49.2
13.8
6.4
26.6
2008
623912.9
46.7
14.1
6.6
28.2
Data sources: China CBRC statistics from 2001 to 2008
TableII
THE COMPETITION OF CHINA'S BANKING FORM 2001TO 2008
year
STABILITY OF CHINA'S COMMERCIAL BANKING
With the deepening of China's financial reform, the
market structure of China's banking industry had great
changes. China had formed competition situation of
state-owned commercial banks, joint-stock banks, city
commercial banks and other banks co-exist, and market
concentration is reduced year by year (showed in Table
I). However, the data in the table shows that total assets
of four major state-owned commercial banks is still
dominant, China's banking industry is still in the stage
of monopolistic competition and has not yet reached the
moderate competition.
Along with financial market competition degree in
the banking industry increasing in China, how does the
banking stability change? We try to analyze it by the
means of correlation analysis between banking
competition and stability. Generally, we use industry
concentration ratio index (CRn) and HerfindahlHirschman Index (HHI) to reflect the competition
degree. From reflection of table II, these two indexes
gradually decreased since 2001, witch indicates that the
competition of China commercial banks enhances
gradually.
The
share of
four
major
stateowned
commerc
ial banks
in total
assets (
%)
Industry concentration
ratio index
( CRn ), n = 4
HerfindahlHirschman Index (
HHI )
2001
0.771
-
2002
0.750
-
2003
0.549
0.390
2004
0.536
0.381
2005
0.524
0.372
2006
0.513
0.364
2007
0.492
0.336
2008
0.467
0.322
To keep the stability of the banking, we can select
the index of bank non-performing loan rate to represent
the banking stability. The rate of non-performing loan is
an important indicator to reflect the banking soundness,
which can reflect the stability of the banking sector in a
certain extent. The smaller the index value is, the better
the stability of the banking is.
This paper analyzed the correlation between the
concentration ratio index of banking industry and bank
non-performing loan rate form 2001 to 2008 , the
correlation coefficient between them is 0.9114 (Table
III), which shows that there is a strong positive
correlation between degree of banking competition and
stability. This analysis also shows that, when not reach
the moderate competition, banking stability will increase
along with the degree of the industry competition
enhanced.
TableIII
THE CORRELATION BETWEEN THE COMPETITION OF
CHINA'S BANKIG AND NON-PERFORMING LOAN RATIO
year
industry
concentratio
n ratio index
(CRn), n = 4
2001
0.771
25.35
2002
0.750
25.00
2003
0.549
17.8
2004
0.536
12.8
2005
0.524
8.6
2006
0.513
7.02
2007
0.492
6.17
2008
0.467
2.45
non-performing
loan rate ( % )
correlation
coefficient
0.9114
Data sources: bank non-performing loan rate data is from the China
finance Yearbook and China Banking Regulatory Commission
statistics.
From the existing literature and the situation of
banking competition and stability in China, the effect of
competition on individual bank stability and banking
system stability is different. On the terms of the
individual bank, competition may improve its stability,
or reduce it, or even collapse. But as a whole of the
banking industry, the competition orderly will enhance
the system stability of the banking under financial
resource constraints, and whether the competition is
insufficient or excessive will bring adverse effect.
IV. SYSTEM STABILITY MECHANISM OF
BANKING UNDER THE COMPETITION
Financial resources are a kind of scarce social
resources, which determined the fierce market
competition among the commercial bank subsystems
and internal banks. This competition promotes system
stability of the banking mainly from two aspects.
On one hand, the banking system is a selforganizing system with dissipative structure. From the
perspective of self organization system evolution, the
competition between banks not only makes banking
system far from equilibrium state, but also promotes the
system to the ordered structure evolution. Under the
condition of market economy, banks face a different
environment and resource condition. The responses of
banks to market competition are also different. So the
competition forms a kind of environmental forces which
make all banks away from the equilibrium, into a
dynamic non- equilibrium [11]. Specifically, competition
can promote banks to carry out a variety ways of
financial innovation, which not only makes the bank
have the enough development at multiple levels, but also
make the bank management efficiency, improve
economic efficiency and promote their competition
ability. At the same time, competition leads to the
emergence of new ideas, new strategy and new
combination in bank system, which promotes the bank's
overall efficiency. In addition, competition can makes
bank effort degree information open to the public, which
could achieve more effective supervision and incentive
to bank operator. Because of the competition makes
banks facing the decisions between life and death, the
bank must constantly improve its management
mechanism and operational efficiency to survive.
On the other hand, the main feature of the
competition is the survival of the fittest. When facing on
the external environment and condition, the different
type banks in banking system have different adaptation
and response, and the acquisition of material, energy and
information quality are also different. All these cause
the competition and survival of the fittest. Survival of
the fittest mechanism of commercial banks have
screening function, which can retain good banks of high
efficiency and eliminate the poor efficiency banks, so as
to enhance the overall quality and stability of the
commercial banking system[10]. Survival of the fittest
mechanism of competition is achieved by price
mechanism. Competition promotes price changes in
financial market, which have different effects on
different banks. Under the environment of market
competition, the bank whose marginal cost is higher
than the market price will incur losses. And if the bank’s
loss endangers bank capital, it will withdraw from the
market. In contrast, the bank whose marginal cost is less
than the market price will continue to live.
In Figure 1, S0 stands for the initial market
equilibrium, P0 and Q0 stand for the corresponding
prices and the number of banking institutions
respectively. With the development of economy, the
financial service demand is increased. Assuming that the
demand increase Q1, the prices will rise to P1 if the
bank quantity is same. On the one hand, the prices
increases profit space of the bank, which makes bank
supply quantity increase and bank competition increase.
And on the other hand, it can inhibit the demand for
financial services, and decline the demand. Falling
demand and survival of the fittest mechanism of
competition make the equilibrium point at S2. And as
this process continues, the banking system will get to
automatic balance.
V. CONDITION OF THE BANKING SYSTEM
STABILITY UNDER THE COMPETITION
To achieve dynamic system stability by self
organization, bank must meet the following conditions:
All bank institutions should adjust their behavior
independently according to the changes in the financial
environment, the diversity of bank institutions which
can realize full competition and the smooth entry and
exit channel of banks for the survival of the fittest.
(1) Independence of bank institutions
An independent bank institution has four basic
characteristics.It provides financial products and
services as the main source of its income, and its goal is
to maximize the benefits. It must have the property
right, by which it has the ability to take full
responsibility and cost. It has the independent
decision-making right. Otherwise, it would produce
asymmetry of duty and right. ④ it has enough
awareness of risk.
Pric
e
The market
supply1
The market
supply2
S1
P
1
P
0
S2
S
0
A
C
1
A
C
1
innovation of financial instruments and financial
transactions of property rights (such as merger,
reorganization, transfer). Bank exit refers to the
alteration or loss of the financial institution legal person
status by the way of merger, division, dissolution,
closure, and bankruptcy [12]. Banking entry and exit
largely determined the competition degree in banking
sector and its quantity. New life is the condition of
ecosystem sustainability. Similarly, the bank entry is
also the conditions of sustainable banking-system and
only with effective access can make good financial
institutions to achieve objectives of expanding the
market and develop new markets or new areas of
business. At the same time, bank entry is condition of
competition too. No free entry, no full competition, and
no full competition, no effective financial function. All
that lives must die, which is the requirement of
ecological balance, and it is also requirements of
maintain financial stability. For those failing bank
institutions, they would eventually threaten the interests
of the public and depositors, so they should withdraw
from the market. The International Monetary Fund's
research also showed that it was vital to run banks exit
on the stability of the banking system and competition.
Fig 1 the dynamic stabilization process of banking system under
competition
VI. CONCLUSION
(2) The diversity of bank institutions
Similar to the stability of the ecological system, the
system stability of the banking also relies on the
diversity of bank institutions and the complexity of
financial food-chain relations. Banking diversity mainly
embodies the following like the diversity of financial
institutions, the diversity of financial property right, the
structural diversity, financial organization diversity,
species diversity, and financial business and service
diversity. In the long-term evolution process, different
bank institutions are different in the organization
structure and organization function, which forms the
food chain of financial organizations by complement
each other and mutually dependent relationship. The
more complex the food chain relation is, the more
abundant nonlinear interaction in system is and the
easier to restore stability under internal and external
interference. Conversely, if banking institutions are the
same in the strategy, business, structure, and asset
concentration, the relationship within banking system is
very simple, and the system will hide the certain
systemic risk. When it receives interference factors, it is
difficult for banking system to restore stability by the
fluctuation among various components of the system.
(3) The smooth entry and exit channel of bank
institutions
In order to make the competitive mechanism of
survival of the fittest smoothly in the banking system, it
needs to have appropriate entry and exit channel for
banks. Entry means that the banking institutions added
branches, opening new financial business, the
Competition is an inevitable product of the market
economy. Competition among banks is the driving force
for the banking development and the necessary
condition to achieve the system stability in the
increasingly globalized financial environment. In the
competition, banking system realizes the dynamic
balance and stability of the system through its selforganization and mechanism of survival of the fittest.
But, to achieve dynamic system stability by self
organization, bank must meet the following conditions:
All bank institutions can adjust their behavior
independently according to changes in the financial
environment, the diversity of bank institutions which
can realize full competition and the smooth entry and
exit channel of banks for the survival of the fittest.
Therefore, in order to promote the stable development of
the banking sector, it is important to reform the financial
system and create a financial environment and
conditions of orderly competition.
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