Business cycle, market power and bank behaviour in emerging countries

This paper tries to overcome the lack of empirical studies on bank cyclical behaviour in emerging countries. According to the literature, market competition is also a relevant determinant of banking stability in emerging countries, but does market power influences the relationship between business cycle and bank behaviour? Drawing from two bodies of literature – business cycle and market power effects on banking stability – this study is the first to give an answer to this question using a quite representative sample of 740 commercial banks installed in 50 emerging countries, observed from 1997 to 2008. Estimation of a simultaneous equations model demonstrates, after several robustness checks that bank capital buffers and loan default risk are negatively correlated with the business cycle, which supports the implementation of the Basel countercyclical prudential tools in emerging countries. The study also shows that market power attenuates the negative relationship between business cycle and bank behaviour, suggesting that banking authorities in emerging countries should also consider the competitive behaviour of banks in implementing countercyclical capital standards.