Competition and risk-taking behaviour in South African commercial banks.

Abstract

The study investigated the relationship between banking competition and risk-taking behaviour of the commercial banking sector in South Africa. This research employed two main theories to explain the relationship between banking competition and risk-taking behaviour, namely the Competition Fragility View and Competition Stability. Competition Fragility theory is to justify the increase in banking competition is the increase in bank risk-taking incentives. While the competition stability theory suggests that in less competitive markets, banks charge higher interest rates, which increases loan default risk. There is an ongoing debate on how competition affect the bank risk taking behaviour. This study observed competition in five dominant commercial banks in South Africa. The study uses a panel dataset spanning twenty years, from 2002 to 2022. The level of banking competitionwas measured by Lerner index and H-Statistic for Panzer Rosse. The fixed effect and random effect models were employed to analyse the effect of competition on South African bank risk-taking behaviour. The fixed effect panel threshold regression model was used to examine whether there is any threshold effect on the relationship between competition and bank risk-taking behaviour in South African commercial banks. Bank risk-taking behaviour amongst three banks was measured by non-performing loans, liquidity risk, capital adequacy risk and the Z-score. The control variables are bank- specific, which are performance and bank size. The macroeconomic context comprised gross domestic product (GDP) and inflation (INFL). The result on the degree of competition estimated by both Lerner index and H-statisticranges between 0 and 1. This indicates a monopolistic competitive banking system amongst South African commercial banks. The results support the hypothesis that competition has an effect on South African banks' risk-taking behaviour. The finding on possibility of a threshold effect suggests a non-linear relationship between competition and risk-taking behaviour. The double threshold suggests more complex interactions where the effect of competition changes significantly at certain points. The research therefore recommends that competition should be encouraged on the South African banking sector. Furthermore, the South African Reserve Bank and policymakers should consider policies such as free entry to the market, lower capital requirements and uncapped interest ratesto encouraged new banks to enter the market.