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Chapter 2 Literature Review
There hasn’t been general agreement on whether the authority should increase or decrease the level of competition to reduce risk to achieve more efficient management and better performance. Researches examining the impact of market competition on risks focus more on banking industry than on insurance industry and therefore our research try to apply the conclusions of former literatures to insurance industry.
Keeley (1990) took American banks as research objective and introduced Tobin’s Q to evaluate the market power of banks. He found that banks with stronger market power have larger capital and face lower default risk. For instance, the level of competition in banking industry in the United States ascended in the 1980s, leading to the reduction of market power and the franchise value and the increasing of bankruptcies. Salas and Saurian (2003) followed Keeley (1990) and applied the method to Spanish banking industry, and they further considered the regulations of government and the risk-taking on asset aspect. The result suggests that standard measures of market concentration do not affect bank risk-taking, but negative relation is found between market power measured by Lerner index based on bank-specific interest rates and bank risk.
Chang et al. (2008) tested the relation between non-performing loans (NPL) of the Brazilian banking system and macroeconomic factors, systemic risk, and banking concentration. They applied a panel data approach with fixed effects. The results find a significant impact of banking
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concentration on NPL, which indicates that financial stability may be improved by more concentrated banking system. Turk-Ariss et al. (2010) studies how the impact of the degree of market power on efficiency and financial stability in the banking industry for a group from emerging economies. They apply three different specifications of the Lerner index of competition and use a Z-index to proxy for financial stability. The results indicate that increased market power brings about greater bank stability.
Boyd and De Nicolò (2005) present contrasting models that relate banking competition to stability and test the relation empirically. They suggest that when the banking market is more centralized, banks with higher market power would raise loaning rate, the borrower would take the investment with higher risk because of the increasing of capitol cost and thus banks have to take higher default risk. De Nicolò and Loukoianova (2007) also find that the positive and significant relationship between bank concentration and bank risk of failure is stronger when bank ownership is taken into account, and it is strongest when state-owned banks have sizeable market shares. André Uhde and Ulrich Heimeshoff (2009) collected European banks’ data from 1997 to 2005 to test the relation between Consolidation in banking and financial stability. They suggest that national banking market concentration has a negative impact on European banks’
financial soundness.
Ren (2006) examined the relation of competitive on risk specifically in the insurance industry. She simultaneously considered the impact of franchise value and the level of competition on risks taken by insurance industry and further applied the effect of underwriting
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cycle. The result shows that when competition becomes intense, firms with high franchise value appear to take more risk in order to maintain their existing market position for stock insurers. For mutual insurers, the risk-constraining effect of franchise value tends to be strengthened when the competition increases. Besides, for homeowner insurance and general liability insurance, when the market is in a slump, the risk-constraining effect of franchise value and risk-increasing effect of competition appear to be stronger. However, the effect of underwriting cycle is relatively not significant for auto personal liability insurance and commercial multiple perils insurance.
Martínez Miera and Repullo (2010) also prove that there is a U-shaped relation between the competition and bankruptcy risk in banking industry. The result shows that the entry of new banks would decrease the bankruptcy risk in a more centralized market, and in a more competitive market, the entry of new banks would increase the bankruptcy risk. Therefore, the relation between the competition and bankruptcy risk is U-shaped. Liu et al. (2013) apply the Lerner index and Z-index as bank competition and bank stability respectively to examine the competition-stability relationship in 11 European banking industries for the period 2000-2008.
The results suggest that a U-shaped relationship between competition and stability existing in European banking.
Jiménez, Lopez and Saurina (2013) use data from Spanish banking system to test relationship between bank competition and risk-taking in the loan market. The result supports this nonlinear relationship by using standard measures of market concentration in both the loan and deposit markets. In addition, when using a direct indicator as a proxy for market power, such as
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Lerner indices, the results appear to be stronger to support the original franchise value hypothesis, but only in the loan market.
Concerning the research about Asia, Liu, Molyneux, and Nguyen (2012) examined the effects of competition on bank risk-taking behavior in four South East Asian countries (Indonesia, Malaysia, Philippines and Vietnam). They find that competition would not increase bank risk-taking behavior in different model specifications, estimation approaches and variable construction. Even so, the result suggests that there is an inverse relation between concentration and bank risk. However, Liu and Wilson (2013) suggest that risk varies across bank types in Japanese banking industry. In addition, the relationship between competition and risk also varies across bank types based on different initial levels of risk. Increasing competition appears to reduce the risk of (City) banks with higher initial levels of risk, but increase the risk of their (Regional, Tier 2 Regional, Shinkin and Credit Cooperative) counterparts with lower initial levels of risk.
Regarding the research in Taiwan, Liu (2009) took the Taiwanese banking industry during 1996-2005 as research objective and used Lerner index to evaluate the market competition. The finding shows that higher market concentration and lower marker competition leads to lower credit risk and earnings variability risk. However, the competition in banking industry doesn’t conduce to the negative relation between marker concentration and credit risk and earnings variability risk.