Abstract:
Purpose – Bank competition and financial stability are often cited as important drivers of economic growth.
Bank competition plays a very significant role in enhancing the efficiency and determining the stability of a
financial system. However, a question of interest is whether bank competition enhances or hindrances the
economic growth of a country. The purpose of this paper is to investigate the role of bank competition and
financial stability on economic growth for selected South Asian economies over the period 1997–2016.
Design/methodology/approach – To investigate whether bank competition enhances or hinders economic
growth, the author applies a two-step estimation technique. First, the author estimates bank competition using
the Lerner index and adjusted Lerner index and, second, examines the joint effect of bank competition and
financial stability on economic growth applying both panel regression model and system GMM techniques.
Findings – Empirical findings reveal that the banking sector in South Asian economies is competitive as
indicated by the estimated values of Lerner and adjusted Lerner index. Moreover, the joint effect defined by
the interaction between banking competition and banking stability also reveals a positive and significant
impact on economic growth. This finding implies that both banking competition and banking stability are
significant long-term determinants of economic growth in South Asian economies.
Practical implications – This paper suggests flexible banking regulation policies such as low net interest
rate margins, lesser activity restrictions and entry of foreign banks along with few contestability measures to
increase bank competition in South Asian countries. This is because as higher the competition, greater is the
chance for efficient allocation of resources and hence economic growth.
Originality/value – This paper is the first of its kind that considers the joint role of bank competition and
financial stability on economic growth. The application of a semi-parametric approach in the estimation of
marginal cost is also a unique contribution to empirical literature.
