Bank concentration, competition and financial stability nexus in the East African Community: is there a trade-off?

Figures & data

Table 1. Definition of variables and sources

Variable	Definition	Source
Financial Stability
Z-score	Average return on assets and equity over total assets divided by standard deviation of return on assets	Fitch Connect and author’s computations
Risk Adjusted Return on Assets (RAROA)	Return on assets divided by standard deviation of return on assets	Fitch Connect and author’s computations
Bank Concentration/Competition
Structural Measures
3-bank Concentration Ratio (CR3)	Combined market share in assets of largest 3 banks in the country	Fitch Connect and author’s computations
Herfindahl–Hirschman Index (HHI)	Sum of squared market shares in assets of all banks in the country	Fitch Connect and author’s computations
Non-Structural Measure
Lerner Index (LI)	(Price—Marginal cost)/Price (%)	Fitch Connect and author’s computations
Bank Specific Variables
Capitalisation	Ratio of equity/total assets (%)	Fitch Connect
Loans to assets	Ratio of loans/total assets (%)	Fitch Connect
Bank size (log TA)	Natural log of total assets	Fitch Connect
Diversification	Total non-interest income/gross revenue (%)	Fitch Connect
Listed banks	Dummy = 1 if listed, otherwise 0	Central Banks Reports
Foreign owned banks	Dummy variable of 1 if at least 50% of shares is owned by foreigners	Central Banks Reports
Government owned banks	Dummy variable of 1 if at least 50% is owned by government	Central Banks Reports
GFC Crisis	Dummy variable of 1 for year 2007–2010 to capture GFC	Author’s computations
Financial Structure Variables
Banking sector development	The ratio of banking sector assets/GDP (%)	World Bank Development Indicator
Stock market development	The ratio of value of shares traded to market capitalization (%)	World Bank Development Indicator
Macroeconomic Variables
GDP Growth	Rate of DGP growth (%)	World Bank Development Indicators
Inflation rate	Rate of change of GDP deflator (%)	World Bank Development Indicators
Real interest rate	Nominal interest rates minus rate of inflation (%)	World Bank Development Indicators

Figure 1. Evolution of financial stability over the period 2001–2018.

Figure 2. Evolution of market structure over the period 2001–2018.

Table 2. Mean values of financial stability and market structure variables across the sample countries

Country	Z-Score	RAROA	CR3	HHI	LI
Burundi	15.11	2.16	88%	29%	42%
Kenya	16.41	1.72	37%	7%	28%
Rwanda	11.57	1.34	66%	20%	30%
Tanzania	11.23	0.96	49%	11%	24%
Uganda	16.23	1.92	40%	9%	24%

Note: RAROA denote Risk Adjusted Return on Assets, CR3—Three-bank concentration ratio, HHI—Herfindahl-Hirschman Index and LI —Lerner index

Table 3. Descriptive statistics for all the variables

	(1)	(2)	(3)	(4)	(5)
VARIABLES	N	mean	sd	min	max
Z-Score	1,805	14.57	12.52	−13.82	126.9
RAROA	1,805	1.554	1.897	−3.717	8.678
HHI	1,805	0.106	0.0570	0.0546	0.536
CR3	1,805	0.453	0.137	0.269	1
Lerner Index (LI)	1,805	0.270	0.273	−3.888	0.723
Bank size (log TA)	1,805	4.986	1.384	0.333	8.856
Diversification	1,805	32.30	17.16	−47.55	100
Capitalisation	1,805	16.61	8.192	4.870	55.39
Loans to assets ratio	1,805	53.48	15.17	1.804	113.3
Listed banks	1,805	0.191	0.393	0	1
Foreign banks	1,805	0.552	0.497	0	1
Government-owned banks	1,805	0.0942	0.292	0	1
Banking sector development	1,805	18.87	8.327	4.114	34.25
Stock market development	1,805	3.826	3.033	0.148	14.78
GFC crisis	1,805	0.211	0.408	0	1
GDP Growth	1,805	5.745	2.084	−3.900	13.19
Inflation	1,805	7.908	5.755	−5.036	34.02
Real interest rate	1,805	8.793	6.397	−9.749	23.00

Note: RAROA denote Risk Adjusted Return on Assets, CR3—Three-bank concentration ratio and HHI—Herfindahl-Hirschman Index

Table 4. Pairwise correlations

Variables	(1)	(2)	(3)	(4)	(5)	(6)	(7)	(8)	(9)
(1) Z-Score	1.000
(2) RAROA	0.482***	1.000
(3) CR3	-0.083***	-0.043*	1.000
(4) HHII	-0.073***	-0.013	0.962***	1.000
(5) Lerner Index (LI)	0.147***	0.464***	0.088***	0.106***	1.000
(6) Bank size	0.016	0.367***	-0.300***	-0.250***	0.295***	1.000
(7) Capitalisation	0.399***	-0.095***	-0.098***	-0.090***	-0.179***	-0.342***	1.000
(8) Diversification	-0.134***	-0.080***	0.041*	0.041*	-0.062***	0.096***	-0.191***	1.000
(9) Loans to assets	0.055**	-0.054**	-0.060**	-0.064***	-0.007	0.065***	0.087***	-0.127***	1.000
(10) Listed banks	0.102***	0.359***	-0.070***	-0.076***	0.097***	0.430***	-0.120***	0.030	0.063***
(11) Foreign banks	-0.016	-0.047**	-0.051**	-0.050**	-0.073***	-0.013	-0.011	0.003	-0.215***
(12) Gov’t banks	0.009	-0.039*	0.074***	0.086***	0.052**	-0.052**	0.099***	-0.033	0.039*
(13) Banking Sec Dev	0.133***	0.075***	-0.429***	-0.357***	0.029	0.318***	0.058**	0.073***	0.294***
(14) Stock Mkt Dev	0.046*	0.079***	-0.240***	-0.230***	0.083***	0.146***	-0.037	0.059**	0.186***
(15) GFC crisis	-0.039*	0.062***	0.018	-0.004	0.021	0.027	-0.047**	0.195***	-0.055**
(16) GDP Growth	-0.111***	-0.004	-0.047**	-0.031	-0.008	0.004	-0.059**	-0.044*	-0.082***
(17) Inflation rate	-0.048**	0.023	-0.009	-0.025	-0.032	0.037	-0.032	0.106***	0.021
(18) Real interest rate	0.079***	0.011	-0.044*	-0.004	-0.010	-0.082***	0.097***	-0.174***	-0.067***
Variables	(10)	(11)	(12)	(13)	(14)	(15)	(16)	(17)	(18)
(10) Listed banks	1.000
(11) Foreign banks	-0.130***	1.000
(12) Gov’t banks	0.017	-0.358***	1.000
(13) Banking Sec Dev	0.153***	-0.260***	-0.007	1.000
(14) Stock Mkt Dev	0.150***	-0.256***	0.017	0.638***	1.000
(15) GFC crisis	0.012	-0.017	0.010	-0.111***	-0.046**	1.000
(16) GDP Growth	-0.006	0.116***	0.039*	-0.311***	0.029	0.039*	1.000
(17) Inflation rate	-0.011	-0.023	0.011	-0.039*	0.163***	0.290***	-0.148***	1.000
(18) Real interest rate	-0.049**	0.147***	-0.030	-0.103***	-0.382***	-0.330***	0.102***	-0.889***	1.000

Note: RAROA denote Risk Adjusted Return on Assets, CR3—Three-bank concentration ratio and HHI—Herfindahl-Hirschman Index. Superscripts ***, ** and * denote significance at 1%, 5% and 10% respectively.

Table 5. Effect of bank concentration and competition on financial stability (Z-score)

	Dependent variable—Z-Score
	(1)	(2)	(3)	(4)	(5)	(6)
VARIABLES	CR3	HHI	LI	CR3 & LI	HHI & LI	LI^2
Lag. of Z-Score	0.162***	0.161***	0.146***	0.129***	0.129***	0.140***
	(0.052)	(0.052)	(0.046)	(0.044)	(0.044)	(0.046)
CR3	0.644***			0.481**
	(0.237)			(0.235)
HHI		1.478***			1.071**
		(0.490)			(0.482)
Lerner index			1.035***	0.701***	0.680***	1.122***
			(0.179)	(0.144)	(0.144)	(0.177)
Lerner index^2						0.384***
						(0.146)
Bank size	0.146***	0.148***	0.116**	0.090**	0.094**	0.105**
	(0.044)	(0.044)	(0.047)	(0.044)	(0.043)	(0.046)
Capitalisation	0.053***	0.053***	0.058***	0.058***	0.058***	0.056***
	(0.004)	(0.004)	(0.004)	(0.004)	(0.004)	(0.004)
Diversification	−0.001	−0.001	0.000	−0.000	−0.000	−0.000
	(0.001)	(0.001)	(0.002)	(0.001)	(0.001)	(0.002)
Loans to assets	−0.001	−0.001	0.000	−0.000	−0.000	0.001
	(0.002)	(0.002)	(0.002)	(0.002)	(0.002)	(0.002)
Listed banks	0.238*	0.237*	0.241**	0.315**	0.310**	0.236**
	(0.141)	(0.140)	(0.117)	(0.127)	(0.127)	(0.115)
Foreign banks	0.041	0.037	−0.036	0.009	0.009	−0.033
	(0.101)	(0.101)	(0.101)	(0.095)	(0.094)	(0.101)
Gov’t banks	−0.108	−0.105	−0.204	−0.195	−0.194	−0.206
	(0.153)	(0.156)	(0.129)	(0.134)	(0.136)	(0.127)
Banking Sec Dev	0.005	0.004	0.001	0.005	0.004	0.002
	(0.006)	(0.006)	(0.005)	(0.005)	(0.005)	(0.005)
Stock Mkt Dev	0.003	0.002	0.006	0.005	0.005	0.008
	(0.012)	(0.012)	(0.012)	(0.010)	(0.010)	(0.012)
GFC crisis	0.239***	0.242***	0.143*	0.148*	0.203**	0.072
	(0.082)	(0.082)	(0.083)	(0.081)	(0.086)	(0.077)
GDP Growth	−0.019*	−0.020*	−0.018*	−0.007	−0.008	−0.019*
	(0.011)	(0.010)	(0.010)	(0.008)	(0.007)	(0.010)
Inflation rate	0.002	−0.003	0.002	0.005	0.002	0.005
	(0.018)	(0.018)	(0.015)	(0.014)	(0.014)	(0.015)
Real interest rate	0.004	−0.001	0.002	0.005	0.001	0.005
	(0.021)	(0.020)	(0.017)	(0.016)	(0.016)	(0.017)
Year Dummy	yes	yes	yes	yes	yes	yes
Observations	1,615	1,615	1,615	1,615	1,615	1,615
Number of banks	149	149	149	149	149	149
AR1 P-Values	0.001	0.001	0.000	0.001	0.001	0.001
AR2 P-Values	0.108	0.111	0.252	0.161	0.160	0.228
Hansen P-Values	0.151	0.170	0.225	0.234	0.273	0.229

Note: CR3 denote Three-bank concentration ratio, HHI—Herfindahl-Hirschman Index and LI—Lerner index. Superscripts ***, ** and * denote significance at 1%, 5% and 10% respectively.

Table 6. Effect of bank concentration and competition on financial stability (Risk-Adjusted Return On Assets (RAROA))

	Dependent variable—Risk Adjusted Return on Assets (RAROA)
	(1)	(2)	(3)	(4)	(5)	(6)
VARIABLES	CR3	HHI	LI	CR3 & LI	HHI & LI	LI^2
Lag. of RAROA	0.364***	0.356***	0.347***	0.379***	0.380***	0.319***
	(0.051)	(0.049)	(0.074)	(0.122)	(0.123)	(0.110)
CR3	1.637***			0.931*
	(0.606)			(0.471)
HHI		3.457***			2.050*
		(1.219)			(1.038)
Lerner index			1.405***	1.854***	1.849***	1.636***
			(0.515)	(0.452)	(0.456)	(0.587)
Lerner index^2						0.997**
						(0.501)
Bank size	0.373***	0.369***	0.244**	0.198**	0.193**	0.222**
	(0.098)	(0.092)	(0.115)	(0.095)	(0.095)	(0.109)
Capitalisation	0.033**	0.038**	0.025**	0.034**	0.034*	0.021*
	(0.015)	(0.015)	(0.012)	(0.017)	(0.017)	(0.011)
Diversification	−0.000	0.003	0.003	−0.001	−0.001	0.001
	(0.005)	(0.005)	(0.005)	(0.007)	(0.008)	(0.005)
Loans to assets	−0.007	−0.006	−0.004	−0.004	−0.003	0.002
	(0.004)	(0.004)	(0.006)	(0.004)	(0.004)	(0.006)
Listed banks	0.526	0.543*	0.648**	0.650***	0.652***	0.599**
	(0.331)	(0.318)	(0.306)	(0.237)	(0.237)	(0.270)
Foreign banks	−0.272	−0.240	−0.173	−0.246*	−0.248*	−0.181
	(0.167)	(0.161)	(0.163)	(0.137)	(0.138)	(0.163)
Gov’t banks	−0.170	−0.230	−0.318	−0.314*	−0.313*	−0.305
	(0.244)	(0.256)	(0.232)	(0.184)	(0.187)	(0.190)
Banking Sec Dev	0.018*	0.013	0.020**	0.018**	0.016*	0.023**
	(0.011)	(0.010)	(0.010)	(0.009)	(0.009)	(0.009)
Stock Mkt Dev	0.004	0.013	−0.042	0.000	−0.001	−0.054**
	(0.025)	(0.026)	(0.027)	(0.026)	(0.026)	(0.025)
GFC crisis	−0.054	0.073	0.701***	0.937***	0.519*	−0.308
	(0.236)	(0.199)	(0.228)	(0.246)	(0.287)	(0.284)
GDP Growth	0.013	0.014	0.066*	0.037*	0.035	0.079**
	(0.024)	(0.024)	(0.036)	(0.021)	(0.021)	(0.032)
Inflation rate	0.069**	0.070**	0.043*	0.082**	0.077**	0.032
	(0.033)	(0.032)	(0.024)	(0.033)	(0.032)	(0.027)
Real interest rate	0.085**	0.084**	0.042*	0.087**	0.081**	0.028
	(0.035)	(0.034)	(0.025)	(0.036)	(0.035)	(0.028)
Year Dummy	yes	yes	yes	yes	yes	yes
Observations	1,615	1,615	1,615	1,615	1,615	1,615
Number of banks	149	149	149	149	149	149
AR1 P-Values	0.000	0.000	0.000	0.000	0.000	0.000
AR2 P-Values	0.176	0.152	0.212	0.355	0.354	0.115
Hansen P-Values	0.211	0.200	0.301	0.371	0.335	0.224

Note: CR3 denote Three-bank concentration ratio, HHI—Herfindahl-Hirschman Index and LI—Lerner index. Superscripts ***, ** and * denote significance at 1%, 5% and 10% respectively.

Table 7. Robustness checks on the effect of bank concentration and competition on financial stability (CR5 and Country-specific bank-level Lerner index)

	Dependent Variable—Z-Score				Dependent Variable—RAROA
	(1)	(2)	(3)	(4)	(5)	(6)	(7)	(8)
VARIABLES	CR5&LI	HHI&LI	LI	LI^2	CR5&LI	HHI&LI	LI	LI^2
Lag of Z-Score	0.130***	0.131***	0.126***	0.119***	0.436***	0.441***	0.348***	0.386***
	(0.043)	(0.047)	(0.044)	(0.040)	(0.127)	(0.126)	(0.075)	(0.132)
CR5	0.643**				1.317**
	(0.277)				(0.563)
HHI		1.547***				3.177***
		(0.477)				(1.116)
Lerner index	0.704***	0.635***	0.559***	0.694***	1.729***	1.714***	1.613**	2.017***
	(0.136)	(0.125)	(0.116)	(0.135)	(0.440)	(0.436)	(0.619)	(0.393)
Lerner index^2				0.196**				1.091***
				(0.092)				(0.258)
Bank size	0.101**	0.109**	0.131***	0.100**	0.240**	0.239**	0.264**	0.219**
	(0.046)	(0.044)	(0.042)	(0.044)	(0.093)	(0.092)	(0.121)	(0.103)
Capitalisation	0.057***	0.057***	0.057***	0.057***	0.033**	0.034**	0.027**	0.006
	(0.004)	(0.004)	(0.004)	(0.004)	(0.015)	(0.016)	(0.012)	(0.015)
Diversification	−0.000	−0.000	−0.001	−0.000	0.000	0.001	0.005	−0.007
	(0.001)	(0.001)	(0.001)	(0.001)	(0.008)	(0.008)	(0.005)	(0.007)
Loans to assets	0.000	−0.000	−0.000	0.000	−0.004	−0.003	−0.004	−0.005
	(0.001)	(0.002)	(0.002)	(0.002)	(0.004)	(0.004)	(0.006)	(0.003)
Listed banks	0.272*	0.272**	0.242*	0.274**	0.531**	0.522**	0.590*	0.471**
	(0.140)	(0.135)	(0.132)	(0.130)	(0.223)	(0.221)	(0.305)	(0.224)
Foreign banks	−0.032	−0.001	−0.038	0.008	−0.222*	−0.224*	−0.200	−0.117
	(0.093)	(0.094)	(0.096)	(0.099)	(0.129)	(0.129)	(0.165)	(0.121)
Gov’t banks	−0.208	−0.176	−0.177	−0.175	−0.332*	−0.318*	−0.409*	−0.351*
	(0.148)	(0.147)	(0.148)	(0.160)	(0.177)	(0.179)	(0.236)	(0.190)
Banking Sec Dev	0.005	0.005	0.001	0.000	0.022**	0.019**	0.019*	0.016**
	(0.005)	(0.005)	(0.005)	(0.005)	(0.009)	(0.009)	(0.010)	(0.007)
Stock Mkt Dev	0.015	0.008	0.012	0.009	0.009	0.006	−0.033	0.007
	(0.010)	(0.010)	(0.011)	(0.010)	(0.027)	(0.026)	(0.027)	(0.022)
GFC crisis	0.177*	0.227***	0.155**	0.094	0.968***	0.511*	0.577***	0.914***
	(0.091)	(0.086)	(0.071)	(0.086)	(0.246)	(0.286)	(0.187)	(0.229)
GDP Growth	−0.016**	−0.013*	−0.023***	−0.021**	0.014	0.019	0.054	−0.005
	(0.008)	(0.008)	(0.008)	(0.009)	(0.019)	(0.019)	(0.037)	(0.018)
Inflation rate	0.015	0.005	0.004	0.008	0.093***	0.084***	0.052**	0.089***
	(0.014)	(0.014)	(0.014)	(0.015)	(0.033)	(0.031)	(0.024)	(0.028)
Real interest rate	0.018	0.006	0.006	0.009	0.100***	0.090***	0.056**	0.097***
	(0.016)	(0.016)	(0.016)	(0.016)	(0.037)	(0.034)	(0.024)	(0.030)
Year Dummy	yes	yes	yes	yes	yes	yes	yes	yes
Observations	1,615	1,615	1,615	1,615	1,615	1,615	1,615	1,615
Number of banks	149	149	149	149	149	149	149	149
AR1 P-Values	0.001	0.001	0.001	0.001	0.000	0.000	0.000	0.000
AR2 P-Values	0.189	0.170	0.185	0.196	0.330	0.304	0.288	0.256
Hansen P-Values	0.208	0.242	0.323	0.230	0.238	0.228	0.297	0.293

Note: RAROA denote Risk Adjusted Return on Assets, CR5—Five-bank concentration ratio, HHI—Herfindahl-Hirschman Index and LI—Lerner index. Superscripts ***, ** and * denote significance at 1%, 5% and 10% respectively.