Abstract

This paper examines the role of interbank competition on banking stability in Jordan, an emerging market. Using competition estimates measured by Lerner index, the paper examines the impact of competition on two important dimensions of banking stability, namely, credit risk and liquidity risk. The empirical results suggest that the effect of banking competition on stability differs according to the dimension of stability. After controlling for bank-level control variables and macroeconomic conditions, the empirical results of the impact of market power measured by Lerner index on credit risk show that an increase in price competition leads to more risk taking from banks. On the other hand, the impact of price competition on the second dimension of banking stability (liquidity risk) implies that an increase in price competition improves the liquidity position of banks. However, these results hold only for the sample of non-Islamic banks. Islamic banks may face wider mismatch between its assets and liabilities due to its inability to use conventional debt instruments offered by the market and hence it keeps larger cash buffers to compensate for this extra risk.

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