Abstract:
Banks in the developing countries are competing in an environment where the financial
infrastructure or the prerequisites for such competition is lacking. Therefore there is a
current debate in banking literature regarding the effect of bank competition on the
stability of the banking sector. The present paper provides new and rather scarce
evidence of effects of banking sector competition on financial stability of the Sri Lankan
banking sector during the period 1996 to 2010. By analyzing a comprehensive set of
panel data the study reveals that the Sri Lankan banking sector is moderately
competitive as per Panzar and Rosse H-Statistic and, highly unstable as per Z- score.
The results of the core analysis provide evidence for a U shape relationship between
competition and stability in the Sri Lankan banking sector during the sample period.
Hence, a different approach emerges, with underdeveloped countries giving a stronger
role to competition authorities to understanding the complex relationship between
competition and stability in the financial sector.
