Asian countries have undergone dramatic economic changes over the last two decades. They have swung from expansionary financial liberalisation to a severe crisis in 1997. Institutional problems were perceived as the origin of such a financial turmoil. Those include corporate sector vulnerability due to weak corporate governance, and the unsupervised financial liberalisation of the 1980s that has resulted in unfettered competition on the credit market, notably in the real estate markets (Sachs and Woo, 2000).
In the aftermath of the 1997 Asian crisis, despite the fact that Asian firms have attracted foreign investment, firms still face corporate governance problems, poor accounting and irregularities, non-transparent management, and a governance system that granted minority shareholders little protection for their interests (Park, 2006). From this channel bank risk becomes again an important issue, since Chang (2004) documents that banking is the predominant source of finance for private sector businesses in Asian countries.
Likewise, several financial reforms, such as bank capitalisations and consolidations, have been implemented to moderate excessive bank competition and to reinforce financial stability. Nevertheless, the effectiveness of such reforms remains questionable. Brana and Lahet (2009) provide evidence that the stringency of bank capital requirements following the 1988 Basel accord in the pre-Asian crisis period played a major role in the capital crunch of Japanese banks and hence shrinking foreign assets held by Japanese banks in Thailand in the 1990s. In regards to bank consolidations, bank mergers and acquisitions have grown rapidly with the growth level reaching 23% per year as of 2003. However, such consolidations do not necessarily build stronger banks. As noted by Cook (2009) consolidation leads to “too big to fail” effects in Asian banks, increasing risk-taking incentives through “gamble for resurrection” strategies to exploit state bailouts and the costs involved in the transfer of losses from shareholders to the taxpayers.
Another contemporary issue in Asia is that the trend of financial globalisation has recently driven Asian banks to evolve both nationally and internationally (Moshirian, 2008). Berger (2003) accentuates that, as banks expand their scope of activities into more various products and identify new growth opportunities across national borders, they are likely to gain market power. Through these channels, moral hazard can also arise and bank supervisors need to raise concern on this issue.
In spite of the importance of these contemporary issues, to our best knowledge, no evidence has yet been found in the Asian context regarding the implications of such developments on bank risk. The aim of this paper is therefore to assess such issues by investigating the impact of market power in the banking industry on individual bank risk and capitalisation in Asian countries after the 1997 Asian crisis. We consider the period 2001-2007 and a broad set of commercial banks in Asian countries that have been affected by the 1997 Asian financial crisis. These include Indonesia, Malaysia and Thailand that were severely devastated by the banking crisis, as well as China, India, Hong Kong, Pakistan, Philippines, South Korea, Sri Lanka, Taiwan, and Vietnam that were less affected.
The rest of this paper is structured as follows. Section 2 provides a literature review on the relationship between market power and bank risk. Section 3 describes the data, variables and provides descriptive statistics. Section 4 highlights the econometric specification and methodology used in this paper. Section 5 provides a broad set of sensitivity analyses. Section 6 concludes the paper.
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Bank Market Power and Risk Taking: Evidence from Asia
