The impact of bank competition to financial stability of Vietnam commercial bank

s a situation in which the financial system (financial market , financial institutions, financial infrastructure) perform its functions smoothly, contributing to the efficient allocation of resources of the economy. System-level risks are accurately assessed and managed effectively to avoid possible collapse of the financial system. At the level of commercial banks, financial stability can be understood as the state in which the organization operates smoothly, performs its function, operates stably and is able to withstand the shock from the external environment, and itself does not cause a shock to the economy. 2.1.2.2. Financial stability and financial instability of commercial banks At present, there is no consensus on an exact definition of the financial stability of banks. Studies on financial stability of commercial banks often consider and evaluate the "level of financial instability" as an approach to assessing "financial stability", and financial instability is the opposite of financial stability. The financial turmoil of commercial banks is often associated with a general banking panic that is related to a bank's shock exaggerated by the behavior of 9 uninformed depositors, who suspect the bank's asset value is lower than the bank's liability value, then withdraw the deposits. When a bank encountered a sudden capital withdrawal by depositors, this can lead to the bank run and cause instability. Due to the majority of lending bank deposit should get when experiencing situations of sudden customer withdrawals of large amounts, the Bank could not immediately refund all the funds sent to the client.The delay paid due to inability to meet this could lead to a run on deposits prompted the Bank into bankruptcy status. The result is that the depositors will suffer damage unless they are the insurance company paid deposits.The fleeing the Bank spread increase unrest led to the banking crisis system.Many examples of the bank run took place, such as the fleeing from the US Bank the year 1930, the collapse of investment bank Bear Stearns in 2008. When a bank encounters a sudden withdrawal by depositors, this can lead to bank failure and cause instability. Because banks lend a large amount of their deposits, banks are unable to immediately repay all deposits to customers when they encounter unexpected situations where there is money withdrawal in large amounts. This inability to pay due to the inability to respond can lead to a runaway deposit that leaves the bank in bankruptcy. As a consequence, depositors will suffer losses unless they are covered by the insurance company. The widespread bank outbreak has increased the instability that has led to a systemic banking crisis. Many examples of bank failures have taken place, such as the failure of the US banks in the 1930s, the collapse of Bear Stearns investment bank in 2008. 2.1.2.3. Methods to measure financial stability and financial instability Financial stability of commercial banks is often measured indirectly through the assessment of financial instability and banking crisis either systematically or individually. 10 (i) Measurement of systematic financial stability and financial instability In order to measure system financial stability, many studies use aggregate metrics for the whole system (Z-scores and distance to bankruptcy), with average or weighted of each rating factor by scale of each bank. The limitation of this approach is that it does not take into account the interrelationships between financial institutions, ie the ability to spread as a financial institution (ii) Measurement of individual financial stability and financial instability Based on Altman's research, many studies have subsequently applied the Z- score to assess bankruptcy risk in various industries. For the banking sector, there are studies by Boyd & Graham (1986), Hannan & Hanweck (1988), Soedarmono & ctg (2011). The degree of financial stability is quantified by Z-score in the banking sector studies and is calculated as follows: 𝑅𝑂𝐴𝑖𝑡is the return on total assets of bank 𝐸𝑄𝑇𝐴𝑖𝑡is the ratio of equity to total assets of bank 𝛿𝑅𝑂𝐴𝑖𝑝is the standard deviation of the bank's ROA 2.1.3. Theoretical background of competition and stability of the banking system From the traditional viewpoint of a "competition - fragility" relationship, a more competition or less centralized banking system increase instability. This is explained by the franchise value theory studied by Marcus (1984) and Keeley (1990), suggesting that competition motivates banks to pursue more risky strategies. These studies show thatless competition or a more exclusive monopoly of some banks will lead to higher franchise value of these banks, and may prevent excessive risky decisions of the bank's executives. Because when the Franchise value is 11 higher, the opportunity cost of bankruptcy is higher, leading to the reluctance of bank executives and bank shareholders to participate in dangerousdecisions, thereby improving the quality of bank assets. Boot and Greenbaum (1993) and Allen and Gale (2000, 2004) show that in a competition environment, banks receive less information from their relationships with borrowers, making it difficult to check credit records and increase the risk and instability. Boyd et al. (2004) argue that banks with a higher level of presence or higher monopolies in a centralized banking system can increase profits and thereby reduce financial breachability by providing "Buffer Capital"to protect the system against macroeconomic shocks and external liquidity problem. From a "competition – stability" standpoint, a more competitive or less monopoly banking system will be more stable, in other words, less competitive or more monopoly banking system will be more unstable. This can be explained by the "too big to fail" theory proposed by Mishkin (1999) indicating that policymakers will be more concerned about the collapse of the bank when there are so few banks in the banking system. Thus, large banks are more likely to receive government guarantees or grants, which can create moral hazard problems, encourage dangerous decisions and increase instability of the banking system. Moreover, the spreadingrisk may increase in the centralized banking system with large banks. Caminal and Matutes (2002) argue that less competition can lead to easier credit granting and larger loans, which increases the probability of bank collapse. Boyd and De Nicolo (2005) argue that high monopoly banking systems allow banks to charge higher interest rates, and may encourage borrowers to take greater risks. Therefore, the amount of non-performing loans can increase, resulting in higher probability of bank’s bankruptcy. However, Martinez-Miera et al (2010) suggests that higher lending rates also bring higher interest income to banks. This offset effect can create a U-shaped relationship between bank competition and stability. 12 2.2. Empirical evidences: 2.2.1. Empirical studies on the level of competition and the factors that influence the level of competition of financial institutions Competition in the banking sector has been a subject that has attracted the attention of many domestic and foreign researchers. Fungacova et al (2010) studied the market power of Russian banks in the period 2001-2007 using the Lerner index. Demirguc-Kunt and Peria (2010) study market power of the banking system in Jordan 1994-2006. Soedarmono et al (2011) studied the competitiveness of commercial banks in Asian countries and territories for the period 2001-2007. Bolt and Humphrey (2012) study the competitiveness of US banks, which use HHI, Lerner and H statistics to measure competition. Repkova (2012) examines the competitiveness of the Czech banking system for the period 2000-2010. Simpasa (2013) examines the level of competition and market structure in the Zambian banking system in Africa in the context of a dynamic market movement involving new and emerging foreign banks and privatization of State-owned banks. Laurent's (2013) study of regional bank competition in Europe, in which the author examines the degree of competition among EU banks in the period 2000-2010 to assess the behavior of banks Europe in this period. Hamza and Kachtouli (2014) examine the level of competition and market power of Islamic banks and commercial banks in the Middle East & North Africa and Southeast Asia for the period 2004-2009. Saibu (2015) studies the competitiveness and concentration of Nigerian banks for the period 2001 - 2013. Phan Thi Thom and Than Thi Thu Thuy (2015) study the impact of competition on the efficiency of cost and profit management of Vietnamese commercial banks in the period 2005 - 2014. 13 Vo Xuan Vinh and Duong Thi Anh Tien (2017) studied the competitiveness and considered factors affecting the competitiveness of Vietnamese commercial banks in the period 2005-2014 2.2.2. Empirical studies on financial stability and factors affecting financial stability of commercial banks Currently, financial stability and factors affecting the financial stability of commercial banks are increasingly interested and attracted many research in the country as well as in the world. Hesse and Cihak (2007) analyze empirically the role of cooperative banks in stabilizing finances. Ivičić and Katt (2008) investigated the impact of macroeconomic variables and banking characteristics on the payment risk of banks in seven Central and Eastern European countries from 1996 to 2006. Soedarmono et al (2011) examined whether Asian banks were morally at risk in the 1997 Asian crisis. Rahman et al (2012) studies the relationship between bank ownership and risk and the impact of government regulation on capital. Fu et al (2014) examines the relationship between competition and financial stability, using information and data from 14 Pacific economies from 2003 to 2010 to examine the effects of bank competition, concentration, and regulations of nations on the fragility of banks which are determined by the bank's probability of bankruptcy and Z-score. Chiaramonte et al (2015) evaluates the accuracy of the Z-score, a widely used representative variable to measure the financial stability of banks, based on the sample of European banks from 12 countries in the period 2001-2011. Strobel and Lepetit (2015) use the Z-score model to evaluate and consider the relationship between Z-score and the bankruptcy probability of banks, which provide a more refined measurement without pressure to set the next distribution assumptions. 14 Hammami & Boubaker (2015) examines the effect of ownership structure on bank risk, using information on financial statements of 72 commercial banks from 10 Middle East and North Africa (MENA) countries over 2000 to 2010. Nguyen Minh Ha and Nguyen Ba Huong (2016) identify the factors that influence the bankruptcy risk of Vietnamese banks by using the Z-score method, thus suggesting appropriate policies to enhance stability and health in operation of joint stock commercial banks in Vietnam. 2.2.3. Empirical evidence of competition and stability of the banking system There have been a number of studies showing that the higher the level of bank competition, the more likely it is that financial instability will be mitigated through a decline in market power, which in turn will reduce profits and lower the value of the brand. These studies support the "competition - fragility" view. In view of this, banks are encouraged to take more risks to increase profitability and to reduce the quality of their loan portfolio (Marcus, 1984, Keeley, 1990 and Carletti and Hartmaan, 2003). However, many recent studies have advocated a "competition-stability" view. Beck et al. (2006) studied a group of 69 countries and found that countries with low market concentration or high competition were less likely to suffer financial crisis. Boyd and De Nicolo (2005) argue that the greater the market power, or the lower the competition in the lending markets, the higher the risk for banks because higher interest rates make repayments to customers more difficult. This can exacerbate ethical risk, and at the same time, higher interest rates will attract higher risk borrowers. In addition, in highly centralized monopolies, financial institutions may believe that they are "too large to collapse" and this can lead to riskier investments (Berger et al. , 2008). Other studies have recently applied the Lerner competitiveness index and measured bank stability through the Z-score to examine the relationship between competition and the stability of the banking system such as Berger et al. (2008), Turk-Ariss (2010), Liu et al. (2010). 15 2.3. Evaluating prior studies 2.3.1. Evaluating previous studies on competition and factors affecting the level of competition of commercial banks It can be seen that there are a number of different studies with different countries, using different methods for differential results related to the measurement of competition and factors affecting the level of competition of commercial banks. Previous studies have identified a number of factors affecting the level of competition of commercial banks, including:  The size of the bank  Capital size  Outstanding loans  Profit  cost management effectiveness 2.3.2. Review previous studies on financial stability and factors affecting the financial stability of commercial banks: There are many different studies with different countries that use the Z-score to measure the bank's financial stability, measuring the level of risk exposure to bankruptcy or financial instability of the bank. The studies yielded different results related to the issue of measuring financial stability and factors affecting the financial stability of commercial banks. The results of the study show that Z-score is a simple and less time-consuming and cost-effective method of measuring financial stability in the banking sector. Previous studies have identified a number of factors that affect the financial stability of commercial banks, including:  The size of the bank  Capital size  Outstanding loans  Profit  cost management effectiveness 16 2.3.3. Review previous studies on the impact of competition on financial stability of commercial banks There are different studies with different countries, using different methods to differentiate the relationship between competition and financial stability of commercial banks. This is the basis for the development of the thesis. Specifically: the first study of the thesis based on the results of Marcus (1984), Keeley (1990), Carletti, and Hartmaan (2003) studies suggests that the higher the level of bank competition, the more likely it is to lead to financial instability, mainly through the decline of market power, which consequently reduces profits, and decreases the value of the brand. These studies support the "competition - fragility" view. The second research point is based on the findings of Boyd and De Nicolo (2005), Beck et al. (2006), Turk-Ariss (2010), Liu et al. (2010), suggesting that the higher the level of bank competition, the more financial stability the banks will be. The reason is that the greater the market power or the lower the level of bank competition in lending markets, the higher the risk for the bank, the higher the interest rate will be and should be more difficult for borrowers to pay. This can exacerbate ethical risk, and at the same time, higher interest rates will attract higher risk borrowers. In addition, in highly centralized monopolies, financial institutions may believe that they are "too large to collapse" and this can lead to riskier investments (Berger et al. , 2008). In this study, the author uses the Z-score to represent financial stability and the Lerner index to represent the level of competition of Vietnamese commercial banks. The thesis also examines the impact of intrinsic factors within the banks, as well as external factors in the macro environment, under normal conditions and in crisis conditions, to test two above hypotheses. The thesis analyzes the latest updated data of commercial banks in Vietnam for the period of 2008 - 2016. The research results suggest solutions to help Vietnamese and SBV managers to have appropriate strategies and solutions. 17 CHAPTER 3: RESEARCH METHODOLOGY AND RESEARCH DATA 3.1. Researh data The study was conducted with a sample of 24 commercial banks in Vietnam from 2008 to 2016. Data for internal variables within the bank were collected from the annual financial statements of commercial banks. Data for external factors of the macro environment are collected from formal sources such as the World Economic Outlook (WEO), data set of the International Monetary Fund (IMF), and General Statistics Office of Vietnam. 3.2. Research Methodology: 3.2.1. Measure and analyse the factors impact the level of competition of commercial banks 3.2.1.1. Measure the level of competition of commercial banks To proxy the degree of competition of commercial banks, we use the Lerner index which has been used by Berger et al. (2008), Fernández de Guevara et al. (2005), Berger et al. Maudos and Solís (2009), Xiaoqing (Maggie) Fu et al. (2014). The Lerner index for banks is calculated as follows: 𝐿𝑒𝑟𝑛𝑒𝑟 = 𝑃𝑖𝑡 − 𝑀𝐶𝑖𝑡 𝑃𝑖𝑡 Where Pit is the output price of bank i in year t, calculated by the ratio of total income to total assets. MCitis the marginal cost of bank i in year t. However, marginal cost can not be observed directly, so it is estimated based on the function of the total bank cost (Ariss, 2010; Fenandez de Guevara et al., 2005; Xiaoqing (Maggie) Fu et al, 2014). 3.2.1.2. Factors impact the level of competition of commercial banks Inheriting related studies, the thesis use below model to analyze the factors affecting the level of competition of commercial banks: Lernerit = α + β1 Lernerit-1 + β2 EQTAit + β3 LOANTAit + β4 ROEit + β5 CIRit + β6BANKSIZEit + β7 GDPt + β8 INFt + uit(3) 18 Besides, to consider the impact of these factors on the level of competition of Vietnam commercial banks under normal conditions and crisis conditions, we add to model (1) a CRISIS dummy variable. The dummy variable value is 1 during the economic crisis of 2008-2009 and is 0 in the remaining years. Specific models are as follows: Lernerit = α + β1 Lernerit-1 + β2 EQTAit + β3 LOANTAit + β4 ROEit + β5 CIRit + β6 BANKSIZEit+ β7 GDPt + β8 INFt + β9 CRISISt + uit (4) 3.2.2. Measure and analyse factors affecting the stability of commercial banks in Vietnam 3.2.2.1. Measure the stability of commercial banks in Vietnam There have been many studies that developed the methods of measuring commercial bank stability, most of which use Z-scores. In this study, we follow the studies of Boyd & Graham (1986Hannan & Hanweck (1988), and Boyd & Ctg (1993) to useZ-scores, which are calculated as follows: 𝑍𝑠𝑐𝑜𝑟𝑒𝑖𝑡 = 𝑅𝑂𝐴𝑖𝑡 + 𝐸𝑄𝑇𝐴𝑖𝑡 𝛿𝑅𝑂𝐴𝑖𝑝 Where: 𝑍𝑠𝑐𝑜𝑟𝑒𝑖𝑡is the Z-score measures the bank i 's financial stability in year t. 𝑅𝑂𝐴𝑖𝑡is the return on total assets of bank i in year t, calculated as the after-tax profit divided by total assets. 𝐸𝑄𝑇𝐴𝑖𝑡is the ratio of equity to total assets of bank i in year t, calculated by the average equity divided by total assets. 𝛿𝑅𝑂𝐴𝑖𝑝is the standard deviation of the bank's ROA in the study period p. 19 According to the above formula, the lower the Z-score, the lower the financial stability of the bank. In contrast, the higher the Z-score, the higher the financial stability of the bank. 3.2.2.2. Factors affecting the stability of commercial banks in Vietnam Inheriting previous studies, the thesis builds a model for analyzing the factors affecting the financial stability of Vietnamese commercial banks as follows: 𝑙𝑛𝑍𝑠𝑐𝑜𝑟𝑒𝑖,𝑡 = 𝛼 + 𝛿𝑙𝑛𝑍𝑠𝑐𝑜𝑟𝑒𝑖,𝑡−1 + 𝛽1(𝐸𝑄𝑇𝐴)𝑖𝑡 + 𝛽2(𝐿𝑇𝐷)𝑖𝑡 + 𝛽3(𝐿𝐿𝑃)𝑖𝑡 + 𝛽4(𝐶𝐼𝑅)𝑖𝑡 + 𝛽5(𝑅𝑂𝐸)𝑖𝑡 + 𝛽6(𝐵𝐴𝑁𝐾𝑆𝐼𝑍𝐸)𝑖𝑡 + 𝛽7(𝐿𝑂𝐴𝑁𝑇𝐴)𝑖𝑡 + 𝛽8(𝐺𝐷𝑃)𝑡 + 𝛽9(𝐼𝑁𝐹)𝑡 + 𝛽10(𝐶𝑅𝐼𝑆𝐼𝑆)𝑡 + 𝜀𝑖𝑡 (6) 3.2.3. Empirical Model to study the impact of bank competition to financial stability To search for empirical evidence for "competition –stability" and "competition – fragility" views, we use dynamic model as follows 𝑙𝑛𝑍𝑠𝑐𝑜𝑟𝑒𝑖𝑡 = 𝛼𝑖𝑡 + 𝛿𝑙𝑛𝑍𝑠𝑐𝑜𝑟𝑒𝑖𝑡−1 + 𝛽1𝐿𝑒𝑟𝑛𝑒𝑟𝑖𝑡 + 𝛽2𝐿𝑒𝑟𝑛𝑒𝑟𝑖𝑡 2 + 𝛽3𝐵𝐴𝑁𝐾𝑆𝐼𝑍𝐸𝑖𝑡 + 𝛽4𝐿𝑂𝐴𝑁𝑇𝐴𝑖𝑡 + 𝛽5𝑂𝑊𝑁𝑖𝑡 + 𝜀𝑖𝑡 (7) In addition, in order to find evidence of the impact of competition on the stability of commercial banks under crisis conditions, we add the crisis dummy variable representing Period of financial crisis. The dummy variable value is 1 in 2008, 2009 and is set to 0 in the remaining years. Specific models are as follows: 𝑙𝑛𝑍𝑠𝑐𝑜𝑟𝑒𝑖𝑡 = 𝛼𝑖𝑡 + 𝛿𝑙𝑛𝑍𝑠𝑐𝑜𝑟𝑒𝑖𝑡−1 + 𝛽1𝐿𝑒𝑟𝑛𝑒𝑟𝑖𝑡 + 𝛽2𝐿𝑒𝑟𝑛𝑒𝑟𝑖𝑡 2 + 𝛽3𝐶𝑅𝐼𝑆𝐼𝑆𝑡 + 𝛽4𝐵𝐴𝑁𝐾𝑆𝐼𝑍𝐸𝑖𝑡 + 𝛽5𝐿𝑂𝐴𝑁𝑇𝐴𝑖𝑡 + 𝛽6𝑂𝑊𝑁𝑖𝑡 + 𝜀𝑖𝑡 (8) The dual impact of competition in crisis conditions on the stability of commercial banks is assessed by the lerner x crisis, as follows: 𝑙𝑛𝑍𝑠𝑐𝑜𝑟𝑒𝑖𝑡 = 𝛼𝑖𝑡 + 𝛿𝑙𝑛𝑍𝑠𝑐𝑜𝑟𝑒𝑖𝑡−1 + 𝛽1𝐿𝑒𝑟𝑛𝑒𝑟𝑖𝑡 + 𝛽2𝐿𝑒𝑟𝑛𝑒𝑟𝑖𝑡 × 𝐶𝑅𝐼𝑆𝐼𝑆𝑡 + 𝛽3𝐵𝐴𝑁𝐾𝑆𝐼𝑍𝐸𝑖𝑡 + 𝛽4𝐿𝑂𝐴𝑁𝑇𝐴𝑖𝑡 + 𝛽5𝑂𝑊𝑁𝑖𝑡 + 𝜀𝑖𝑡 (9) 20 3.2. Estimation methodology The thesis estimated models (3), (4), (5), (6) using SGMM method. Model reliability tests performed include: Autocorrelation test of the residual: According to Arellano & Bond (1991), the GMM estimate requires a first order correlation and no quadratic correlation. Model fitment tests and representative variables: Similar to other models, model fit can be done through F-tests. The models (7), (8), (9) are estimated by the Difference GMM (DGMM) method of Arellano & Bond (1991). 21 CHAPTER 4: ANALYSIS OF BANKING COMPETITION, FINANCIAL STABILITY AND IMPACT OF COMPETITION TO FINANCIAL STABILITY OF VIETNAMESE COMMERCIAL BANK IN 2008 – 2016 4.1. Overview of research sample Table 4.1: Descriptive Statistics of sample Variables Obs Means Std. Dev. Min Max Dependant variable Zscore 216 24,6960 12,1832 1,3217 62,1955 Lerner 216 0,2958 0,0849 0,0214 0,6085 Independant variable BANKSIZE 216 17,9791 1,2564 14,6987 20,7299 LOANTA 216 0,5113 0,1564 0,0047 0,8517 CIR 216 0,8932 0,0795 0,6137 1,2187 ROE 216 0,0843 0,0866 -0,8200 0,2846 GDP 216 0,0592 0,0048 0,0525 0,0668 INF 216 0,0904 0,0693 0,0063 0,2312 EQTA 216 0,1125 0,0811 0,0241 0,9994 Source: Calculating result from Stata The correlations matrix between variables is as follow: 22 Table 4.2: correlations matrix between variables Source: Calculating result from Stata 4.2. Measure and analyze the factors affecting the level of competition of Vietnamese commercial banks in the period 2008-2016 4.2.1. Measure the level of competition of Vietnamese commercial banks in the period 2008-2016 Based on the calculation formula of Abba Lerner (1934), the author calculates the Lerner index for 24 commercial banks in Vietnam from 2008 to 2016. Financial data were collected from 24 commercial banks in Vietnam for the total number of observations of 216. Lerner's calculation results are shown in Appendix 2, whereby the Lerner index is the highest in the nine years 2008-2016 of 60.85% belonging to TIENPB in 2008, the lowest in 9 years 2008-2016 is 2, 14% in TIENPB in 2011, Lerner average in 9 years in 2008-2016 of commercial banks in Vietnam reached 29.58%. Compared with the studies conducted in other countries and regions in the world, Lerner of commercial banks in Vietnam in the period 2008-2016 was 29.58% higher than 26.53% of Indonesia in 2003 - 2010, 26.71% of Pakistan during 2003-2010 (Fu et al, 2014) and much lower than Singapore's 48.89%, China's 43.43% (Fu et al, 2014). Thus, when using Lerner to measure the crisis 0.1676 -0.2766 0.1855 0.2004 -0.0538 -0.0492 -0.2595 0.1459 0.1385 0.5375 0.3908 -0.1877 1.0000 own -0.2320 0.4664 -0.2206 -0.1299 -0.0443 0.0798 -0.1273 0.1829 0.0477 -0.1814 -0.0447 1.0000 lerner 0.2213 -0.5132 0.5292 0.3601 -0.0887 -0.0324 -0.8412 0.3823 -0.1033 0.2953 1.0000 inf 0.2151 -0.3193 0.2308 0.2177 -0.0916 -0.1263 -0.1737 0.0773 -0.2286 1.0000 gdp -0.1419 0.1884 -0.1417 -0.05