The effects of market power on stability: Do diversification and earnings strategy matter?

Abstract

This paper examines whether the effect of the level of market power on bank soundness depends on the banks' decision to diversify and adopt a particular earnings strategy. We conduct the empirical approach in two stages. First, we estimate the Boone indicator, which is the measure for bank market power. We then regress this measure and other explanatory variables on the bank risk focusing on the role of earnings and diversification strategies. The results show that competition increases earnings management as the level of market power increases when banks diversify into non-interest income generating activities. The results also suggest that the relatively low insolvency risk among banks in Africa is attributed to the high degree of market power and the diversification strategy employed over the period.