Concentration-stability vs concentration-fragility. New cross-country evidence

Does concentration in the banking sector boost banks’ resilience, or make them more fragile? We propose an analysis of the simultaneous impact of several mediators of concentration on the stability of the banking sector. Results from a sample of world economies observed from 1997 to 2015 support the hypothesis that the impact of mediators is non-linear and depends on the level of concentration. If concentration is at about 50% or lower, increasing concentration improves the stability of the banking sector via profitability. If concentration is at 65% or above, increasing concentration further makes the banking system more fragile because of the mediating effects of credit risk, diversification, and ease of monitoring. For intermediate levels of concentration, the impact of the competing moderators cancels each other out. If aggregated upon concentration, these non-linearities give rise to a non-monotonic impact of concentration on the stability of banks. We thus contribute novel insights into the complex nexus between banking market concentration and financial stability. Further, we add to the policy debate by finding that an intermediate level of concentration is optimal from the policymakers’ perspective.