Competition and Risk-Taking Behavior of Commercial Banks: Evidence from Bangladesh

Abstract

This study evaluates the role of competition on the propensity to take risks in the case of Bangladeshi commercial banks. We have used yearly data from 2009 to 2022 for a sample of 29 publicly traded banks. The Lerner Index was used to measure market power or competition, whilst Risk-Weighted Assets (RWA) and Loan Loss Provision (LLP) were used as indicators to evaluate the risk-taking propensities of the banks. We have used fixed effects, random effects, and feasible generalized least square regressions to examine the correlation between competitiveness and risk-taking behavior. A robust and statistically significant association is observed between the Lerner Index and Risk-Weighted Assets irrespective of the consideration of macroeconomic variables. A similar trend between Lerner index and Loan Loss Provisions is also evident. The results indicate that an increase in market dominance or a decrease in market competition leads to a higher allocation of high-risk investments and reserves for probable loan defaults.

Keywords:
Lerner Index; Risk-Weighted Assets (RWA); Bank Competition; Loan Loss Provision (LLP); Bangladesh.