Competition, capital growth and risk-taking in emerging markets: Policy implications for banking sector stability during COVID-19 pandemic

Abstract

This paper investigates how banking competition and capital level impact on the risk-taking behavior of banking institutions in the Middle East and North Africa (MENA) region. The topic is perceived to be of significant importance during the COVID-19 pandemic. We use data for more than 225 banks in 18 countries in the MENA region to test whether increased competition causes banks to hold higher capital ratios. Employing panel data techniques, and distinguishing between Islamic and conventional banks, we show that banks tend to hold higher capital ratios when operating in a more competitive environment. We also provide evidence that banks in the MENA region increase their capitalization levels in response to a higher risk and vice versa. Further, banking concentration (measured by the HH-index) and credit risk have a significant and positive impact on capital ratios of IBs, whereas competition does play a restrictive role in determining the level of their capital. The results hold when controlling for ownership structure, regulatory and institutional environment, bank-specific and macroeconomic characteristics. Our findings inform regulatory authorities concerned with improving the financial stability of banking sector in the MENA region to strengthen their policies in order to force banks to better align with capital requirements and risk during the COVID-19 pandemic.