Essays on bank profitability, stability and efficiency: the impact of financial inclusion and bank competition

Abstract

This thesis bundles four empirical studies and focuses on the role of bank competition and financial inclusion on bank performance–profitability, stability and efficiency. The first essay uses bank-level data from an emerging market economy–India– and finds that credit risk (defined as NPL ratio) has negative effects on profitability, and it is more pronounced for foreign-owned banks. However, this dampening effect diminishes as bank size increases. The second essay exploits membership variation of Indian banks of a unique institutional mechanism–Corporate-Debt-Restructuring (CDR)–to test whether banks that have restructured corporate loans and made use of extensive regulatory forbearance on asset classification and provisioning on those loans, improve their stability for the period 1992-2012. We find robust evidence that CDR improves banking stability of the treated banks but this treatment effect decreases as the market power of banks increases. Together with bank stability, broadening access to finance has become an important public policy priority since the global financial crisis. Therefore, in the final two essays, we first construct a composite index of financial inclusion for 87 countries for the period 2004-2012, and then show robust evidence that an inclusive financial sector is good for bank stability, cost and profit efficiency in a sample of 2,913 banks using different estimation techniques and methodologies. These effects are stronger when banks have higher market power and operate in countries with stronger rule of law and institutional quality. The results in this thesis are novel in the literature and have important public policy implications. First, Indian policymakers should emphasise further improvement of asset quality and strike the right balance while promoting bank competition along with having a stable banking sector. Second, policymakers around the world should introduce more enabling inclusive financial environment to ensure sound and efficient functioning of banks while achieving financial inclusion as a development goal.