Beyond Bank Competition and Profitability: Can Moral Hazard Tell Us More?

The purpose of this paper is to investigate the relation between competition, profitability, and risk. The investigation uses bank-level panel data from 171 Chinese banks during 1993 to 2007. Throughout the whole sample, the empirical results divulge that increased bank concentration in China improves the profitability and the risk of its banks. These results support the structure-conduct-performance and the moral hazard hypotheses. In terms of persistence, both the profit and the risk of the banks rise significantly by showing the enhancement of profit and risk from one period to the next. When different types of banks are considered, joint-stock banks have the highest persistence in profit and risk, and therefore more stable profits. City banks support the moral hazard hypothesis. They have entrenched managers that tend to take on more risk when the bank’s charter value falls in a very competitive (less concentrated) environment. Further, deregulation which in 2003 China allowed foreign banks to formally enter China has a negative impact on the structure of China’s banking sector.