Abstract
In this study, we investigate the potential contribution of bank competition to macroeconomic stability, and the interactive role of financial development. We classify macroeconomic stability into economic and financial stability. Economic stability is represented by the volatility of actual and unexpected output growth, whereas financial stability is assessed by the aggregate Z-score and volatility of the private credit-to-gross domestic product ratio. We employ two structural and two non-structural measures of bank competition in our analysis. Applying a two-step dynamic panel system (GMM) to macroeconomic data from 48 developing nations from 1999 to 2018, we find a bell-shaped relationship between bank competition and macroeconomic stability. The findings imply that a higher level of bank competition promotes macroeconomic stability by reducing output growth volatility, fluctuations in private credit, and the probability of bank default. There is an optimal level of bank competition exists beyond which it may foster economic and financial instability. Moreover, financial development enhances bank competition’s positive impact on macroeconomic stability.
•The study investigates the potential contribution of bank competition toward macroeconomic stability.•The interactive role of financial development is also examined in this framework.•The study classifies macroeconomic stability as economic and financial stability.•Economic stability is represented by the volatility of actual and unexpected output growth.•Financial stability is assessed by aggregate Z-Score and the volatility of private credit to GDP ratio.•The study applies two-step dynamic panel system GMM to macroeconomic data from 48 developing nations from 1999 to 2018.•The results suggest a bell-shaped relationship between bank competition and macroeconomic stability.