Journal of Applied Finance & Banking

Competition's Effect: Unveiling the Simultaneous Relationship between Risk and Cost of Financial Intermediation

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• Abstract

   

  This study examines the simultaneous association between risk and cost of financial intermediation (CoFI) by examining the effect of competition at different high-average-low levels from 2010 to 2021. The empirical findings of the two-step system generalized method of moments (2GMM) depict few significant insights based on 44 commercial banks in Bangladesh. The study finds that risk and CoFI are inversely related to each other in the short run and positively associated in the long run. Moreover, competition shows a heterogenous effect on risk and CoFI in both the short and long. However, in the long run, in a competitive market, incremental risk enhances CoFI, but a high CoFI target also increases risk. Finally, considering the CoFI, the average level of CoFI reduces the risk; however, considering risk, the high-risk and low-risk levels can enhance CoFI. Level of competition advocates average competition since it increases the cost of intermediation and reduces risk. Also, in average-level competition, incremental risk significantly increases the CoFI. This study provides a banking balancing act of risk-return tradeoff and Structure-Conduct-Performance (SCP) paradigm policy implications for emerging nations' financial system growth.

   

  JEL classification numbers: C30, C50, G21, G32.

  Keywords: Cost of Financial Intermediation, Risk Management, Competition, Two-step system GMM, Simultaneous relationship.