Competition and Stability in the European Union Banking Sector

This paper empirically tests the two competing hypotheses regarding the relationship between competition and stability: the competition-fragility hypothesis and the competition-stability hypothesis. The banking sector stability is proxied with the estimated Z-score, which provides a measure of overall bank stability. Two different measures are used to represent bank competition: the Herfindahl-Hirschman Index (a specific measure of market concentration) and the Boone indicator (which measures competition from an efficiency perspective). Using data from the Moody's Analytics BankFocus database and the World Bank Global Financial Development database, the paper applies panel estimations to a relatively large panel, including 784 relevant banks from all 27 European Union countries, between 2006 and 2021. The main findings overall confirm the validity of the competition-fragility hypothesis. Moreover, the results obtained for two specific European Union countries, Germany and France, highlight some specific differences, particularly regarding the effects of bank market concentration and the responses to the crises that affected the European Union banking institutions over the considered period. The findings of this paper reinforce the relevance of the policy maker's role and indicate, for example, that bank market competition in the European Union is probably already sufficiently high and should not be reinforced, as overall, the increase in bank competition seems detrimental to the stability of European Union banking institutions.