Impact of Competition on Risk Taking Behaviour of Commercial Banks in Kenya

Abstract

A strong financial system is key for efficient performance of an economy. Banks are the dominant institution in a financial system and their health reflects the wellbeing of the entire economy. They however face a variety of risks that hamper their operations. Amongst the risks credit risk is the most important. This study uses the ratio of gross non-performing loans to gross loans in a bank‟s asset portfolio as a proxy for credit risk. The study assumes a competition-risk relationship and seeks to explain the nature of the relationship using an unbalanced panel data of the Kenyan commercial banks for the period from 2008 to 2015.Two measures of competition the HHI and market power ratio were used to measure competition and the system Generalised Method of Moments (GMM) estimation techniques are employed. Estimation results show that the HHI is positive and significant in both model specifications. This implies that an increase in bank competition lowers the credit risk as proxied by non-performing loans. The estimation results therefore supports the risk-shifting paradigm which suggests that when competition in the banking industry increases, fewer losses are likely to arise through non-performing loans.