Etikonomi

Volume 22(2), 2023: 409 - 428

P-ISSN: 1412-8969; E-ISSN: 2461-0771
https://doi.org/10.15408/etk.v22i2.31003

The Impact of Banking Competition on Bank Financial Stability:

Evidence from ASEAN 5 Countries

Mahjus Ekananda
Faculty of Economics and Business, Universitas Indonesia, Indonesia
E-mail: [email protected]

JEL Classification: Abstract

E5 In the era of the global economy, increasing banking competition
G15 will encourage an increase in banking transactions and activities.
G01 Banking transactions and activities will affect a country's
G32 financial stability. The purpose is to obtain the nonlinear
C24
effect of banking competition on financial stability at a
specific regime. Previous research assumed that this impact
Received: 08 February 2023
applies to every economic regime. The impact of banking
Revised: 09 May 2023 competition on financial stability can change at certain regime
levels. Nonlinear impact occurs according to the regime. The
Accepted: 10 June 2023 method is based on a nonlinear threshold regression model.
The researchers obtained the data from five ASEAN countries.
Published regularly: September 2023 The findings of this research are in-depth information about
the financial system stability model. Analysis of the effect of
variance supports the inconsistency of the effects found by
several previous researchers. Practical implications are aimed
at policymakers to make different decisions at the GDP level,
CAR, and Liquidity. The economic regime in each country
is different, so this analysis is constructive for policymakers
to see the conditions of banking competition and financial
system stability at a certain regime level. The originality article
systematically offers an analysis that assumes the effect can
change at a certain regime level.

Keywords:
banking competition; financial stability; distance to default;
threshold regression

How to Cite:
Ekananda, M. (2023). The Impact of Banking Competition on Bank Financial Stability: Evidence from ASEAN 5
Countries. Etikonomi, 22(2), 409 – 428. https://doi.org/10.15408/etk.v22i2.31003.

Copyright © 2023 by Authors.

This is an open access article under CC BY-SA license (https://creativecommons.org/licences/by-sa/4.0)
Mahjus Ekananda. The Impact of Banking Competition on Bank Financial Stability

INTRODUCTION
Southeast Asia countries have implemented the ASEAN Economic Community
(AEC), which generally encourages competition to promote fair economic development.
After the financial crisis, we found that the banking industry in five Southeast Asian
Countries increased the number of loans and loan margins and decreased the number
of deposits. Because competition in banking can cause different impacts on the loan
and deposit market, it is interesting to study this period of economic expansion (Lee
& Fukunaga, 2014). The banking industry in Southeast Asian countries has undergone
significant changes since the Asian financial crisis occurred in the year 1997, caused by
the credit bubble decline of the Thai baht. This condition was followed by the global
financial crisis in 2008, started by Mortgage loan bubbles in the United States. Chen
& Du (2016) and Kasman & Kasman (2015) discovered that, even after these crisis
conditions, the banking industry in Southeast Asia is still prone to moral hazard; the
Asian banking industry is experiencing high market power and better capitalization but
high capitalization has not solved the moral hazard problem in less competitive markets.
Competition is often viewed as a positive force, but on the other hand, competition
can decrease Charter value as the primary source of bank profit (Kabir & Worthington,
2017). Higher market power can increase the credit risk of borrowers as higher interest
rates are charged on commercial loans, known as moral hazard issues, as shown by the
Lerner index for the loan (Castro, 2013; Chaibi & Ftiti, 2015; Kasman & Kasman,
2015). They argue that the Lerner index for the deposit and loan markets describes
different characteristics that must be calculated separately.
Banks with high market power could cause a higher degree of instability among
large banks, thus making more ambiguous linkages between competition in banking and
financial stability (Yusgiantoro et al., 2019b). Wang (2018) found that competition can
diminish the franchise value of a bank, and the result can force banks to pursue riskier loan
projects to maintain former banking profits. The Distance to Default provides a forecast
for the probability of default of the market value of assets (Anginer et al., 2014). Market
power is related to greater systemic fragility. It suggests the importance of guaranteeing a
competitive market condition in banking, supporting the competition stability perspective.
However, the weakness of this method is that the Distance to Default method needs to
consider banking solvency risk from income volatility in banking operations (Castro, 2013).
A competitive market structure has various implications for economic policy; the
degree of competition can become imperative for the efficiency of production, increasing
demand for products and improving them, fostering the quality of products, improving
productivity growth, and generating innovation in many industries (Anginer et al.,
2014), however, in the banking industry. Beck et al. (2013) found that the impact of
competition was more unclear in theory, and banking competition had good and bad
effects on financial stability. The quality of financial products is determined by moral
hazards and the degree of competition, which is related to the degree of innovation
because banks that compete tend to do a lot of innovation and customer acquisition,

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which may harm financial stability, as competition causes banks to increase their credit
and loan allocation and is associated with fragility (Barbosa et al., 2015; Braun et al.,
2019; Chaibi & Ftiti, 2015; Ekananda, 2019).
In most industries, competition is considered a positive force Barbosa et al. (2015),
but in the banking industry, competition is detrimental to financial stability (Dwumfour,
2017). Banking struggle has good and bad effects on financial stability. The Competition
Fragility hypothesis suggests that banking system competition makes the financial system
vulnerable to shock (Beck et al., 2013; Kabir & Worthington, 2017; Quijano, 2013).
Increased competition could lead to increased lending rates, insolvency risk, and reduced
banks' market power. It can be dangerous because competing banks are more willing
to increase risk-taking with credit allocation. The Competition Stability hypotheses were
studied by (Anginer et al., 2014; Arping, 2019; Diallo, 2015; Dwumfour, 2017; Fu
et al., 2014; Kabir & Worthington, 2017; Lu et al., 2022; Mateev et al., 2022). They
propose that banking competition can improve financial stability, resulting in higher asset
quality, efficiency in banking operations, and reduced likelihood of a crisis. Moreover,
the higher competition encourages banks to impose risk-taking incentives, making the
banking system more supple to shock.
Finding suitable methods to explain the impact of banking competition on financial
stability is essential. We use threshold regression to detail its impact by dividing data by
threshold value and analyzing the consistency between Distance to default (DtoD) and
Z-score as a proxy for financial stabilities. There are two hypotheses in the literature
on competition among financial institutions, explicitly of competition stability and
fragility. The competition stability hypothesis studied by several researchers is that banking
competition can improve financial stability, as higher competition promotes banks to
increase their prudential risk-taking incentives. This condition can result in higher asset
quality, increased efficiency in banking operations, and reduced likelihood of a crisis,
as well as making the banking system more resistant to shocks (Anginer et al., 2014;
Arping, 2019; Diallo, 2015; Dwumfour, 2017; Fu et al., 2014; Kabir & Worthington,
2017; Lu et al., 2022; Mateev et al., 2022).
Two methods can measure competition. The first approach uses the structural
method (market concentration) and the structure conduct performance (SCP) versus the
efficient structure hypothesis. The following approach included the H-statistic developed
by Panzar and Rosse (1987). The Lerner index of market power is known as the new
economics of empirical industrial organization (Han et al., 2017).
In the banking industry, there are many ways to measure financial stability. The
macro-financial risk can be used for evaluating the risk of banks and financial institutions
at different aggregations (Anginer et al., 2014). The famous method is Merton Distance
to Default. It measures the Distance between the market value of an asset and the barrier
of default. This method indicates the number of standard deviations away from the
default obstacle to the market value of assets, and it can be extended into probabilities
of default if the circulation of assets is known (Kliestik et al., 2015).

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Mahjus Ekananda. The Impact of Banking Competition on Bank Financial Stability

From the competition-fragility perspective, in recent literature, Diallo (2015) has

cast off the Z-score to show the positive connection between competition and financial
fragility and support the hypothesis. For the Asian banking industry, Souza (2016)
used the Z-score to capture bank income volatility, capitalization in banking, and bank
insolvency risk to evaluate financial stability. The empirical results indicated that high
market power is related to superior capital adequacy. The Lerner index that is more
suitable for banking competition is the Monti-Klein model, which separates the Lerner
index of market power for loans and deposits as proposed by Van den End (2016).
Monti and Klein's model examined banking activities related to collecting deposits and
providing customer loan services.
The novelty of this study is as follows. The study divides stability measures according
to the Distance to Default from a bank's market value and Z-score measures. Moreover,
the size of the competition follows competition in banking, namely from deposit funding
and credit development. The study compared two measures of financial stability to
determine the difference between the Distance to Default Risk measure of a bank's
market value and the Z-score measure of volatility risk income. The study used the
Lerner Index for the deposit (LernerD) and lending (LernerL) markets, a more suitable
method for measuring banking industry competition. Another novelty is that this research
applies threshold regression to obtain analysis results for different economic regimes. The
advantage of this method is that researchers obtain a threshold value that is useful for
optimally dividing economic conditions into several regimes.
Our research gap is explained as follows. This study examines the relationship
between bank competition and financial stability, asking whether competition is feasible
or insufficient for financial stability by measuring competition. In the linear model, the
estimated effect is the effect that applies to all regimes, data, and situations. This study
applies the threshold regression method to look for the non-linear effect of independent
variables on financial stability in various economic regimes (Asare et al., 2021).
The contribution of the paper can be explained as follows. This research requires
measurement of competition that can consider the competition on banking loans and
deposits. We consider the Lerner Monti-Klein index model, which separates the Lerner
indices for the loan market and deposit market as proposed by (Bikker et al., 2012).
This research applies a non-linear model compared to a linear model, resulting in a
broader analysis where the threshold regression model produces a specific effect on a
particular regime. Threshold regression can choose a threshold value to separate two or
three regimes.
This paper aims to provide future predictions about the banking industry competition
for various banking economic and financial regimes. Using this specification can show
banking operations that generate income from interest on loans and maintenance costs
from interest on deposits. This specification also examines the behavior of monopolistic
banks challenged by an elastic demand curve for loans and the supply of deposits (Khan
et al., 2018; Kusi et al., 2020). This research aims to open insights into analysis that
has assumed a fixed effect in all economic conditions. The effect of each determinant

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of financial stability is different for various regimes. We apply threshold regression to

obtain a non-linear erection at the appropriate regime.

METHODS
The samples consist of two large, two medium, and two small banks from the five
Southeast Asian countries. The banks' ratings were identified from institution rankings
for each country from Orbis Bank Focus database, World Bank, and financial statements
from the monetary authority in each country for 2012–2021. We employ this sample
following Montes and Carlos (2015) and Ye et al. (2012), in which they use Spanish
bank data that can reflect competition between large, medium, and small-sized banks.
The result is not robust instead, it is consistent with the expected significant result from
panel data.
Using the panel data approach, we can examine the connection between bank
competition, capital adequacy and GDP to the systemic risk Distance to Default in the
banking industry in five Southeast Asian countries (Model I). We employ this approach
because there are numerous advantages to using this econometric specification. First, there
is the ability to concede time variation and cross-sectional discrepancy in our model.
Second, this method permits us to avoid several biases among cross-country regressions.
Third, there is the likelihood that using influential variables will reduce bias, such as in
the model by Fu et al. (2014).
(1)
In theory, we expect . The empirical model
that examines the connection between bank competition, capital adequacy and GDP to
the financial stability of the Z-score in the banking industry is as follows (Model II):

(2)
where the independent variable includes the market power for loans (LernerL) and market
power for deposits (LernerD), macroeconomic variable GDP growth to account for
country revenue, capital adequacy ratio as variable to control the degree of competition,
Liquidity as variable that reflects operational risk, and the error term. In theory, we
expect . Model I was developed to the Threshold
Regression Panel Data, where gGDP is specific for each regime while the bank variables
are the same. This model applies gGDP as a threshold (Model III)).

(3)
The specific impact of gGDP is expected to be positive for all levels of gGDP.
Model IV was developed with the Threshold Regression Panel, where gGDP is specific
for each regime during the same bank variables and the same dummy bank for each
regime. This model determines gGDP as the threshold (Model IV).

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Mahjus Ekananda. The Impact of Banking Competition on Bank Financial Stability

(4)
This study applies threshold regression because of the assumption that the
effect of the variables is not linear at the level of GDP, CAR and Liquidity (Model
III and Model IV). Threshold regression is as follows. Parameters 𝛾j and 𝛽j are
estimated according to the same least squares procedure used for the standard STAR
or SETAR. The operationalization of the dependent variable is as follows. We follow
the Merton Distance to Default model based on Castro (2013) and Anginer et
al. (2014). Default occurs when the company asset values fall below the default
point (d*).

(5)

We use Distance to Default follow Black–Scholes (BSM) option pricing model (Kliestik
et al., 2015).

(6)

Where: E is the Equity, F(t) is the current market value of the company asset,
d* is the value of debt also called default point, σF is the annualized market value of
the company asset with calculation (market value of asset x volatility of market value
asset) , T is the time until debt matures. A higher distance to default implies higher
financial stability in the distance between market value of banks to the default risk
(Kliestik et al., 2015).
Second measurement by Z-score natural logarithm method. This measurement is
based on Return on Average Assets (ROAA), which can capture bank income volatility,
capitalization and insolvency risk (Anginer et al., 2014).

(7)

Where ROAA is the return on average assets, SDROAA is the standard deviation of
the bank return on average assets, and EQTA is the total equity to total asset ratio
originally used as a measure of bank leverage. High volatility predicts uncertainty in
banking operation can reflect that bank is on the brink of bankruptcy, while low
volatility reflects bank economic condition is steadier. A higher ZROAA implies lower
financial stability.
In the introduction, there is a debate about the existence of diverse, inconsistent,
insignificant, and variable effects (Kusi et al., 2020). The varying effects are caused
because the estimated data consist of various regimes with particular economic behavior
(Anginer et al., 2014). The effect is insignificant because in linear regression, the
effect is the average of all the times and countries involved. Variable effects due to
changes in periods and units of analysis are not robust, caused by outliers at various
positions. To start the analysis using nonlinear methods, we must ensure the presence

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of linearity in the model. Following the background and literature, we state the
hypothesis as follows:
H1 : There are non-linearity influences of banking competition on financial stability
Under the purpose of the study, we use deposit funding and credit development as
the real banking competition. The study used the Lerner Index for the deposit (LernerD)
and loan (LernerL) markets. Second, banking competition affects the Distance to Default
risk measure of the bank's market value and the Z-score measure. Theoretically, both
Lerner indices affect financial stability in linear models and threshold regression. This study
expects that analysis with threshold regression displays the same and more profound results
than linear regression. Hypotheses are proposed in research to prove the compatibility
between theory and empirical studies. The hypothesis is given as follows.
H2 : The increase in banking competition of deposits influences the decrease in financial
stability.
H3 : The increase in banking competition for loan influence the increase in financial
stability
H4 : The increase in economic growth influences the decrease in financial stability.
The discussion of the research results starts with an explanation of the data
description and continues with data testing and model selection. The steps for model
selection are presented as follows—first, the panel data co-integration test, second, Wald
test to choose an individual effect, third, linearly test, robust test and model evaluation
for hypothesis Statistical hypotheses to answer the research hypothesis are as follows.
Proof of the hypothesis by testing the t statistic as follows. We prove the H2 where the
financial stability is the DtoD by testing the significance of . We prove the
H1 where the financial stability is the ZCO by testing the significance of .
In the same way, we do on the H3 and H4.

RESULT AND DISCUSSION

Next, we examine the relationship between our model for the five Southeast Asian
countries' banking industries. Table 1 shows the Distance to Default calculation for six banks
in each country. We calculate the weighted average Distance to Default using the Merton
Distance to Default model, the data obtained monthly for each bank (Kliestik et al., 2015).

Table 1. Distance to Default Result

DD 2015 2016 2017 2018

INA Mandiri 4396,82 5447,74 2811,13 2978,08
BRI 3047,82 3938,25 2056,99 2259,58
BNI 5417,20 6265,39 2652,77 2799,81
BTN 3805,72 4952,32 2049,92 2263,30
BJB 2416,17 926,62 907,09 989,20
Bukopin 13454,47 9775,11 7870,67 4730,13

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Mahjus Ekananda. The Impact of Banking Competition on Bank Financial Stability

DD 2015 2016 2017 2018

MAL Maybank 5379,14 4893,98 5091,32 6572,97
CIMB 2167,13 1881,70 2340,91 4307,63
Public bank 1916,83 2559,71 3892,05 4285,09
RHB 14722,41 22562,57 23765,51 17806,61
Affin bank 2903,97 2654,62 3824,18 5329,29
Alliance bank 2229,43 1984,19 2122,58 5512,76
PHI BDO 2016,63 3158,13 1879,53 2446,30
Metropolitan 4915,17 14069,12 6263,71 8552,00
BPI 2252,20 6740,58 5802,65 8716,60
Security bank 2979,42 3383,97 2176,92 2649,38
East west 10380,19 9756,11 5115,47 4738,53
BOC 2756,73 2671,46 3368,90 2888,23
THA Bangkok bank 7390,04 6557,24 7942,64 7635,28
Siam bank 2536,97 2906,52 4158,38 4526,82
Kasikorn 14294,27 18765,61 19159,15 22582,94
Krung Thai 4341,44 6250,25 7348,21 8212,53
Thanachart 5476,67 6582,71 6736,09 7606,09
Tisco 6571,87 4796,55 1826,67 1861,91
SIN DBS 4445,02 7767,69 5479,90 5121,26
OCBC 6361,76 10368,18 6178,13 6523,68
UOB 4933,95 7543,62 6579,04 6541,45
Hong Leong 5478,31 12733,78 7275,79 4101,15
Singapura 16753,29 16802,38 14507,02 16309,89
Gk Goh 21410,26 19284,47 20196,52 22764,12

A higher distance to default implies higher financial stability in the distance between
market value of banks to the default risk. In contrast, a high degree of Lerner index
implies the higher market power of banks and low market competition level. There
are several root unit testing methods in the STATA and Eviews, in this study, the test
used was ADF - Fisher Chi-square, where Fisher's test is possible for unbalanced panel
data (Ekananda & Suryanto, 2021; Greene, 2018). The Fisher Chi-square ADF test is
used with lag (1), with the results of testing all stationary variables at the level with a
significant level of 1% (Table 2).

Table 2. Panel Unit Root Test Levin, Lin & Chu t

Variable Statistic P-Val Variable Statistic P-Val
DtoD -8.17092 0.0000 CAR -1.12422 0.0000
ZCO -179.983 0.0000 LernerD -62.043 0.0000
LernerL -63.8299 0.0000 Liquidity -10.9411 0.0000
gGDP -14.1528 0.0000

To ensure the selection of our best models, we applied Redundant Fixed Effects
Tests. The common effect Model assumes no heterogeneity of corporate credit share by

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country. On the contrary, the random effect model assumes no corporate credit share
heterogeneity by country. Greene (2018) explains that in the analysis of panel data models,
we can use the Fixed Effect Model (FEM) regression model or the Random Effect Model
(REM). The Hausman test can be performed if we find a suitable regression model. Ho
shows the model using REM, while if H0 is rejected. The result is that FEM will be
used (Table 3). Model I and III used Country as ID. Model II and IV used bank as ID.

Tabel 3. Test Random Effect

CEM vs FEM FEM vs REM
ID Equation
d.f. F-stat Prob F-stat Prob.
Country Model I (4,230) 4.46 0.00 21.05 0.0008
Model II (4,230) 4.44 0.00 21.99 0.0005
Bank Model III (29,205) 17.88 0.00 101.50 0.0000
Model IV (29,205) 4.34 0.00 16.58 0.0134

We use Terasvirta Sequential Tests. Tests are based on the third order. In the Taylor
expansion alternatives equation: b0 + b1*S[ + b2*S2 + b3*S3 + b4*S4]. The Null Hypothesis
H03: b1=b2=b3=0. We define GDP, CAR and Liquidity as the threshold variables. The
results of the linearity test are shown in Table 4. Table 4 explains that the application
of the threshold can be made. The test results of all threshold variables indicate that the
linear model is rejected. If we use a linear equation, the coefficients show a nonlinear
impact. Nonlinear impact (threshold regression) can be interpreted as the independent
variable's impact is not the same for all data conditions. The threshold application can
be made to explore the impact of changes in the condition of the threshold variable.
Table 4 proves the H1: There are non-linearity influences of banking competition on
financial stability. Further studies can be seen in the research by (Ekananda & Suryanto,
2021). The proper method will produce more efficient estimated econometric equations.
The size of the sum square of residual (SSR) is used to determine a more efficient
method (Mahjus Ekananda & Suryanto, 2021 and Greene, 2018). Table 4 and Table 6
summarize the SSR values of the various methods used in the study.

Table 4. Linearity Tests

Model III Model IV
Threshold
CAR GDP Liq CAR GDP Liq
F 2.76 5.12 3.71 4.79 8.30 3.27
d.f. (10, 300) (10, 300) (10, 300) (10, 300) (10, 300) (10, 300)
p-value 0.00 0.00 0.00 0.00 0.00 0.00
Linear Rejected Rejected Rejected Rejected Rejected Rejected
*) Original model is rejected at the 5% level using H03. +)at the 5% level using H03.

Model I was a Fixed Effect model with five country effects. Regression uses the
Eviews application, which applies the Cross-section SUR (PCSE) standard errors &

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Mahjus Ekananda. The Impact of Banking Competition on Bank Financial Stability

covariance (d.f. corrected) and Linear estimation after a one-step weighting matrix. Model
I (Table 5) assumed that each country has its different nature. A higher distance to default
implies higher financial stability in the distance between market value of banks to the
default risk. An increase in GDP growth results in a decrease in financial stability. The
higher market power of banks on loans (lower market competition of banks on loans),
resulted in a decline in financial stability. Likewise, the higher market power of banks
on deposits (lower market competition of banks on deposits) has resulted in increased
financial stability (Barbosa et al., 2015).

Table 5. Fixed Effect for Bank and Country

Dependent Ln(DtoD) : Model I for country Ln(ZCO) : Model II for bank
Indep sign Coef t-Stat Sign Coef t-Stat
C 9.642 21.877 3.959 15.261
LERNERL - -4.391 -4.9998 + -1.512 -2.905
LERNERD + 0.647 3.055 - -0.439 -1.714
GDP - -0.075 -2.027 + 0.022 1.393
CAR - -0.057 -1.738 + 0.040 1.635
LIQUIDITY + 0.002 1.240 - -0.006 -2.044
AdjR2 0.280 0.372
F-stat 13.947 6.211
SSR 140.119 101.708

In model II (Table 5), financial stability was measured by Ln(ZCO), showing that
higher ZCO implies lower financial stability. The increase in GDP growth increased
the ZCO index (the lower financial stability). The higher market power of banks on
loans (lower market competition of banks on loans), increased the ZCO index (lower
financial stability). Regression results show parameters that are not significant. Expected
direction of influence is not proven. Likewise, the higher market power of banks on
deposits (lower market competition of banks on deposits), resulted in a decrease in
the ZCO index (increased financial stability). This result follows the Barbosa et al.
(2015) research.
The link between competition and financial stability in financial institutions has been
a subject of academic arguments; many researchers have aimed to determine the influence
of banking competition following a series of events, such as economic regulation, on
financial stability. This paper used the sample of two large banking firms, two medium-
sized firms, and two small firms in each Southeast Asian country to represent banking
competition from 2012 to 2021.
Models I and II do not consider the differences in GDP, CAR and liquidity
regimes. In the following analysis, we apply threshold regression to produce complete
analysis. Table 6 illustrates the general regression relationship between the Distance
to Default, previous Distance to Default, Lerner index, GDP growth, and capital
adequacy ratio. The threshold regression was used for panel data (1) regression with

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the full set of the model (2) regression with Lerner index only for loans with another
complete variable (3) regression with Lerner index only for deposits with another
complete variable.
Model III (Table 6) explains the regression results where the equation is divided
at a certain threshold. Specifically for Model III, the dependent variable is Ln(DtoD).
A higher distance to default implies higher financial stability in the distance between
market value of banks to the default risk. An increase in GDP growth results in a
decrease in financial stability. The higher market power of banks on loans (lower market
competition of banks on loans), resulted in a decline in financial stability. Table 5 and
Table 6 prove hypothesis H2: the increase in banking competition of deposits commonly
influences the decrease in financial stability.

Table 6. Threshold regression (Model III)

GDP 6.03 CAR 12.76 LIQ 17.73
Ln(DtoD) < 6.03 <= GDP < 12.76 <= CAR < 17.73 <= LIQ
-- 222 obs -- 78 obs -- 252 obs -- 48 obs -- 169 obs -- 131 obs
1 2 3 4 5 6 7 8 9 10 11 12
Coef t-stat Coef t-stat Coef t-stat Coef t-stat Coef t-stat Coef t-stat
LERNERL - -4.32 -4.55 -3.45 -1.34 -5.63 -6.03 2.57 0.99 -4.87 -4.50 -2.88 -2.35
LERNERD + 0.79 3.66 -0.18 -0.24 0.90 3.90 0.62 1.44 0.32 0.95 1.06 4.09
GDP - -0.11 -2.04 0.16 1.88 -0.08 -2.09 -0.14 -0.65 -0.09 -2.07 -0.07 -1.67
CAR - -0.06 -1.54 -0.20 -2.92 -0.12 -3.01 -0.03 -0.45 -0.07 -1.99 -0.13 -3.40
LIQUIDITY + 0.00 1.57 -0.01 -0.85 0.01 1.34 -0.06 -2.48 0.01 0.83 0.00 2.37
AdjR2 0.30 0.32 0.32
SSR 134.82 130.78 130.67
N of observations= 30 Period included T = 10, N of balanced panel observations= 300

Likewise, the higher market power of banks on deposits (lower market competition
of banks on deposits), resulted in increased financial stability. Table 5 and Table 6 prove
hypothesis H3: Commonly, The increase in banking competition for loan influence
the increase in financial stability. This result follows the Barbosa et al. (2015) research.
The effect of market competition on loans and deposits occurs evenly at all levels of
GDP, CAR and liquidity. The low significance level of GDP and CAR in Table 5
has been explained in Table 6. The effects of GDP and CAR are not uniform for
several regimes.
Table 7 shows the general regression relationship between Z-score, previous Z-score,
Lerner index, GDP growth, and capital adequacy ratio using the threshold method of
panel data. (1) regression with full set of the model (2) regression with Lerner index
only for loan with another variable complete (3) regression with Lerner index only for
deposit with another variable complete. A higher Z-score implies a high degree of financial
fragility, greater bank income volatility, and high risk of bank capitalization. In contrast,
a high Lerner index score implies a high bank market power with low competition level.
The table's capital adequacy ratio shows each country's capital burden.

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Mahjus Ekananda. The Impact of Banking Competition on Bank Financial Stability

Table 7. Threshold regression (Model III)

GDP 4.91 CAR 12.61
LIQ
Ln(ZCO) < 4.91 <= GDP < 12.61 <= CAR
-- 300 obs
138 -- obs -- 162 obs -- 245 obs -- 54 obs
1 2 3 4 5 6 7 8 9 10
Sign Coef t-stat Coef t-stat Coef t-stat Coef t-stat Coef t-stat
LERNERL + 2.95 2.03 -2.74 -1.85 0.90 0.72 2.79 1.05 0.21 0.13
LERNERD - -0.69 -2.13 -0.36 -1.02 -0.85 -2.68 -1.38 -3.24 -0.62 -1.64
GDP + -0.02 -0.24 0.35 7.02 0.11 3.51 0.70 3.78 0.13 3.88
CAR + 0.27 10.03 0.13 6.30 0.28 12.45 0.03 0.52 0.23 11.66
LIQUIDITY - -0.01 -2.72 -0.01 -2.15 -0.01 -3.26 -0.01 -0.27 -0.01 -2.41
AdjR2 0.34 0.330329 0.262
SSR 105.01 106.8351 86.23
N of observations= 30 Period included T = 10, N of balanced panel observations= 300

Model IV (Table 7) describes the regression results in dividing the equation into two
regimes. Specifically for Model IV, the dependent variable is financial stability measured
by Ln(ZCO), showing higher ZCO implying lower financial stability. The increase in
GDP growth increased the ROAA (the lower financial stability) index. Table 7 proves
the hypothesis H4: The increase in economic growth influences the decrease in financial
stability.
The higher market power of banks on Loans (lower market competition of banks
on Loans/ LernerL), resulted in an increase in the ZCO (the lower financial stability)
index at a low GDP level. In the CAR and Liquidity regime, the effect is not significant
and is not in the expected direction. If we look at Table 5, it appears that the LernerL
Impact does not match the expected sign. Table 7 proves the hypothesis H2: commonly,
the increase in banking competition of deposits influences the decrease in financial
stability (ZCO). Likewise, The higher market power of banks on deposits (lower market
competition of banks on deposits), resulted in increased financial stability. Table 7 proves
the hypothesis H3: The increase in banking competition for loan commonly influences
the increase in financial stability (ZCO).
The higher market power of banks on deposits (lower market competition of banks
on deposits/ LernerD), decreased the ZCO index (increased financial stability). The
direction of change occurs in almost all applied regimes. These results support Table 5
where the effect of LernerD is negative but insignificant. Significant results only occur
in certain economic regimes, namely at low GDP and CAR levels. This result follows
the Barbosa et al. (2015) and Van den End (2016) research.
The effect of market competition on loans and deposits occurs evenly at all levels
of GDP, CAR and liquidity. The low significance level of GDP and CAR in Table 5
has been described in Table 6. The effects of GDP and CAR are uneven across several
regimes. The Z-score is positively linked with previous Z-scores. The Lerner index of
market power had a significant connection with Z-score only in loan market, it shows
support for competition-stability hypothesis. While in deposit market show support for

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Volume 22(2), 2023: 409 - 428

competition-fragility hypothesis our result is the same as Kabir & Worthington (2017)
and Kanga et al. (2021). Bank competition-fragility portion in deposit increased in degree
of competition makes bank not stable in deposit market. Bank with higher market power
in loan market tend to increase bank income volatility, which suggests Charter value
hypothesis exist bank with higher market power tend to make it harder to repay loan,
bank with high market power are not stable in loan market competition but stable in
deposit market competition. This result follows the Barbosa et al. (2015) and Van den
End (2016) research.
Table 8 presents the data distribution smaller than the GDP, CAR and LIQ
thresholds. This analysis is also by (Ekananda, 2019). We can combine Table 8 with
Table 6. The coefficients obtained in Table 6, GDP < 4.69 (Table 6, columns 1 &
2) are from the countries mentioned in row 1, in Table 8. 90 observations are from
Malaysia and Singapore. Regression results for CAR < 11.61 (Table 6, columns 5 &
6) are from Malaysia, Thailand, Philippines and Singapore. Regression results for Liq
< 17.73 (Table 6, columns 9 & 10) are equally distributed across countries. Table 8
explains the impact of banking competition variables on financial stability in more detail.
The regression results are detailed because the sample is divided into two according to
the threshold value. This threshold value can be examined further by looking at the
countries of origin of these banks. Further analysis can deepen the relationship between
financial stability and the country's economy. The country's economy through GDP.

Table 8. Distribution of data below the threshold

Model III INA MAL THA PHI SIN TOTAL %
1 GDP < 0 6 42 6 36 90 37.5
2 CAR < 6 42 42 42 48 180 75.0
3 LIQ < 30 28 21 39 18 136 56.67

Table 9 describes data distribution smaller than the GDP, CAR and LIQ thresholds.
We can combine Table 9 with Table 7. The coefficient obtained for GDP < 4.69 (Table
7, columns 1 & 2) is from the countries mentioned in row 1, Table 9. 108 observations
are from Malaysia and Singapore. Regression results for CAR < 11.61 (Table 7, columns
5 & 6) are from Malaysia, Thailand, Philippines and Singapore. Regression results for
Liq < 17.73 (Table 7, columns 9 & 10) are equally distributed across countries. The
distribution of country data in Table 9 is similar to Table 8.

Table 9. Distribution of data below the threshold

Model IV INA MAL THA PHI SIN TOTAL % data
1 GDP < 6 18 42 6 36 108 44
2 CAR < 18 48 48 48 48 210 86.0
3 LIQ < 8 19 2 29 9 67 28.02

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Mahjus Ekananda. The Impact of Banking Competition on Bank Financial Stability

Table 10 shows the Payoff matrix of impact banking competition on financial

stability using two competition measurements and two financial stability measurements.
Our results show a reason and benefit for separating the sample from the threshold
criteria to obtain a more specific impact (Models III and IV) than the general impact
(Models I and II). We have chosen the FE model to consider heterogeneity between
countries and banks in these four models.

Table 10. Payoff Matrix of Impact Banking Competition to Financial Stability

Model Financial Stability LernerL LernerD GDP
Model I DtoD (-) (+) (-)
Model II ZCO (-) (+)
Model III DtoD (-) (+) (-)
Model IV ZCO (+) (-) (+)

Specifically, the result from our calculation can be summarized as matrix,

higher Lerner index means higher monopoly power low degree of competition, and
vice versa lower score Lerner index means the degree competition is higher. The
higher Distance to Default means banks are far from the risk of becoming default.
While Zscore ROAA is a measure of bank income volatility positive relationships
mean there is a disruption of banking solvency from banking operations (Kasman
& Kasman, 2015).
From the findings above, it can be stated that banking competition has various
impacts on bank stability. Each bank can have advantages in different variables. This
diversity will have an impact on bank competition, competitiveness, and stability.
The Lerner Index calculates the existence of market power by comparing the price
difference and marginal cost and dividing it by price. The higher the Lerner Index
value, the greater the market power, which means that the bank can set prices above
its marginal cost. When this happens, industry competition will decrease.
This study analyzes the impact of banking competition in the ASEAN region on
bank stability, indicating competition stability or fragility. This research is consistent
with the research penelitian (Anginer et al., 2014; Berger et al., 2009; Chu, 2015;
Davis et al., 2020; Dwumfour, 2017; Fu et al., 2014; Köhler, 2015; Yusgiantoro et
al., 2019a). This study also uses the distance-to-default method to measure banking
stability using a market approach (Anginer et al., 2014; Chan-lau & Sy, 2007).
High competitiveness in the ASEAN region will also impact banking stability.
Competition to compete for market share that is not accompanied by the principle
of prudence will have a negative impact on banking stability. Increased competition
between banks in the market will force banks to make efficient (Jeon et al., 2011).
Inefficient banks will be unable to compete with more efficient banks. If an inefficient
bank is not immediately merged/acquired, it will cause the bank to collapse. Banks
have a systemic impact if banks compete with each other and cause a collapse, the

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Volume 22(2), 2023: 409 - 428

effect will spread to other banks terbuka (Lee & Fukunaga, 2014; Weill, 2009). This
condition is undoubtedly a dangerous condition for the economy as a whole. Each
ASEAN-5 country, especially Indonesia, must anticipate the high competition that occurs
in ASEAN-5 banking (Severe, 2016).
In current developments, several banks in the ASEAN region are carrying out
a product diversification strategy by selling products or services through consulting
services, investment banking, multi-finance or bancassurance, and other non-bank services
(Dang, 2020). One of the factors that can encourage ASEAN banking competition
is the ASEAN Economic Community (AEC). Economic liberalization and integration
through the AEC have made the market within ASEAN more open (Lee & Fukunaga,
2014; Weill, 2009).The enactment of the ASEAN Economic Community (AEC), where
banking in ASEAN is integrated, makes the ASEAN-5 banking competition more
competitive (Severe, 2016).
Competition does not only occur between large foreign banks and local banks but
also between large banks in ASEAN, which compete with each other for markets outside
their own countries. Large banks, especially in ASEAN-5 countries, are implementing
several strategies to compete with each other for control of the regional market. With
the integration of the ASEAN economy, which aims to create a single market, it will
be very profitable for a bank if it can dominate the regional market with a broader
market reach. The formation of the ASEAN Economic Community (AEC) led to policies
related to banking in ASEAN-5 (Chan et al., 2016). One of these policy frameworks
is the ASEAN Banking Integration Framework (ABIF) which is an ASEAN initiative
to facilitate ASEAN banking integration, namely by increasing the role of ASEAN
banks in the ASEAN region through providing convenience in terms of market access
and flexibility to operate in ASEAN member countries (De Jesus & Torres, 2017). The
banking integration process within ABIF uses the mechanism for determining Qualified
ASEAN Banks (QAB). QAB is one of the requirements for banks to operate fully
in other ASEAN countries. The application of ABIF will provide opportunities and
potential for banks to expand into the ASEAN market and gain market access and
broader business activities in the ASEAN region. This activity will encourage intense
competition between domestic and foreign banks from the ASEAN region (De Jesus
& Torres, 2017).

CONCLUSION
The results of our research have proven the H1 hypothesis, where the increase
in banking competition of deposits influences the decrease in financial stability. The
proof uses models I and III, where the Distance to default is the stability. The proof
uses Model I and Model III, where the Z Score measures stability. The nonlinear
method succeeded in proving and developing the results of the linear model analysis.
Insignificant impacts on the linear model can be broken down and explained using
a nonlinear model divided according to a specific threshold value. Market forces'

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Mahjus Ekananda. The Impact of Banking Competition on Bank Financial Stability

impact on loans and deposits can be more clearly seen using a nonlinear model.
Our results show that the Competition-Fragility hypothesis occurs in the Distance
to default measurement. The market power of loans and deposits can stabilize the
financial system. This evidence can be seen from the regression Model I and Mel III
results. While the Lerner index for loans and deposits shows a different relationship
on the ROAA Z-score, the Stability of Competition hypothesis only occurs in the
loan market.
For this reason, each local bank must anticipate the entry of ASEAN regional
banks into the country so that local banks will not lose competitiveness with foreign
banks. Banking is required to increase its efficiency by optimizing the use of its
inputs and outputs so that the profit generated is higher. In addition, banks must
also anticipate ABIF by raising capital, quality of human resources, and information
technology. Digital banking penetration in Asia is growing from time to time. The
strategy that can be carried out is to strengthen the banking structure, which can be
started by increasing bank capital to increase banks' ability to manage business and risk
through mergers and consolidation. However, large banks with sufficiently good capital
use a strategy by opening direct branches in other countries of interest to penetrate a
broader market. Big banks can also make acquisitions to increase their market share.
The management of banking risk management must also be continuously improved.
Credit risk management can be carried out by monitoring various efforts to maintain
NPLs in all bank business segments. Operational risk management is carried out by
implementing Good Corporate Governance (transparency, accountability, responsibility,
independence, and fairness) and monitoring compliance with prudential provisions set
by the central banks of each country.
The recommended policy to control the level of competition is to set the capital
adequacy ratio at an optimal level that can withstand the volatility risk of bank income.
We find evidence for the competition fragility hypothesis and the competition stability
hypothesis affecting ASEAN countries in 2012-2021. Future research should consider
studying the evolution of financial market problems in terms of the level of banking
competition for the loan and deposit market with a sample of other countries.

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