Inter-linkages between competition and stabilisation policies in the banking sector and stock market development in Europe

ABSTRACT

The banking sector and the stock market in Europe have been adversely impacted by a series of global financial crises over the last two decades. Major financial reforms were implemented to enhance the stability and competition within the banking sector. Measures were also implemented to create a vibrant stock market in Europe to stimulate economic growth in Europe. This study examines the interactions between stock market development, banking competition, and banking stability in European countries from 1996 to 2016. The purpose of the study is to understand the inter-linkages between these variables to ascertain the spillover impact of policy reforms in the banking sector on the stock market and vice-versa. Using a vector error-correction model, the study finds long-run and short-run inter-linkages between banking competition, banking stability, and stock market development in European countries. The study’s most robust result is that banking competition and banking stability stimulate stock market development in the long run. There is also some evidence that healthy competition in the banking sector and stock market development instils greater stability in the banking sector. The results suggest that policy measures put in place to create a vibrant stock market must include elevating banking competition and banking stability, with policymakers being cognizant that causality may be bidirectional.

KEYWORDS:

• Stock market development
• banking competition
• banking stability
• European countries

JEL CLASSIFICATION:

• E44
• G32
• G38

Acknowledgments

The authors appreciate the helpful comments of an anonymous reviewer of this journal.

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

¹ For example, see Coccorese (2004), Levine (2001), Beck, Demirguc-Kunt, and Levine (2004), Guzman (2000), Cetorelli and Gambera (2001), and Levine (1998), to name a few.

² See, for example, Allen and Gale (2004), Beck (2008), Broecker (1990), Hellmann, Murdock, and Stiglitz (2000), Shaffer (1998), Martinez-Miera and Repullo (2010), and Wagner (2010).

³ See, for example, De Nicoló, Jalal, and Boyd (2006), De Nicoló and Lucchetta (2009), Schaeck, Cihak, and Wolfe (2009), Jeon and Lim (2013), and Schaeck and Cihak (2014).

⁴ The choice of this time period was due to the availability of the data needed to undertake advanced panel data analysis for these three variables under study. Specifically, the choice of starting year of 1996 was due to the fact that it was challenging to obtain detailed data, especially for banking competition and banking stability in European countries, for earlier years.

⁵ As noted earlier, while the Beck, De Jonghe, and Schepens (2013) study considers stock market turnover, it does not entertain a full set of indicators for stock market development.

⁶ The variables used to proxy for banking competition were selected based on variables used in previous studies. See, for example, Amidu and Wolfe (2013), Andrievskaya and Semenova (2016), Berger, Klapper, and Turk-Ariss (2009), Beck (2008), Beck, De Jonghe, and Schepens (2013), Fiordelisi and Mare (2014), Hauner and Peiris (2008), and Tabak, Fazio, and Cajueiro (2012).

⁷ The variables used to proxy for banking stability were selected based on variables used in previous studies. See, for instance, Amidu and Wolfe (2013), Berger, Klapper, and Turk-Ariss (2009), Beck, De Jonghe, and Schepens (2013), Fiordelisi and Mare (2014), and Tabak, Fazio, and Cajueiro (2012).

⁸ Cointegration would suggest existence of a long-run equilibrium relationship among the variables even though short-term departures from equilibrium may exist.

⁹ The unit root test was used to determine the stationarity of all variables. The test procedures follow the assumption of both common unit root process and individual unit root process.

¹⁰ Results of both panel unit root and panel cointegration tests are available on request and are not reported here due to space constraint.