Market power and risk of Central and Eastern European banks: Does more powerful mean safer?

- CEE banks with higher market power are perceived by financial market as less risky.
- These banks are better capitalised with respect to the distribution of their returns.
- and they are even much better when they hold less-diversified and less-liquid assets.
- and when they operate within a stricter banking regulation.
- Diversification, liquidity and banking regulation play a risk-stabilising role.

As understanding the market power-risk relationship in CEE banking systems is of the utmost importance to policy-makers in these countries, we investigate whether CEE banks must have greater market power to be safer. Our results suggest that more market power reduces the fragility of banking institutions, on one hand, and that banking market concentration tends to make these banks riskier, on the other. Our findings are robust to whatever form of market power-risk relationship and whatever market-power measures we use. More precisely, financial markets perceive CEE banks with more market power as less fragile, while the latter are also better capitalised with respect to the distribution of their returns. Moreover, they are even (much) better capitalised when they hold less-diversified and less-liquid assets and when they operate within a stricter banking regulatory environment, which suggests a risk-stabilising role for diversification, liquidity and the bank regulatory environment in these countries.