Competition-Stability Relationship in the Banking Sector Jelena TITKO Department of Corporate Finance and Economics, Riga Technical University 6 Kalnciema str., Riga, LV-1048, Latvia and Konstantins KOZLOVSKIS Department of Corporate Finance and Economics, Riga Technical University 6 Kalnciema str., Riga, LV-1048, Latvia and Gulbakhyt KALIYEVA Higher School of Economics and Management of the Caspian University 521, Seifullin str., Almaty, Kazakhstan ABSTRACT The goal of the current research is to study the competition- stability relationship in the Latvian banking sector. Research period covers seven years – from 2007 till 2013. The sample consists of 16 Latvian commercial banks. Financial data is extracted from BankScope database. The main method applied to achieve the established goal is a multiple regression analysis. Bank stability is used as a dependent variable and proxied by risk index. To measure the level of competition Lerner index and Boone indicator are calculated. Besides, the consistency between concentration and competition measures is tested applying a correlation analysis. Concentration in the banking sector is measured using Herfindahl-Hirschman Index (HHI) and concentration ratio CR5. Calculations are performed in SPSS environment. The research revealed no statistically significant relationship between the values of Lerner index and Boone indicator estimated for Latvian sample. The hypothesis about the consistency between different competition measures is rejected. In turn, the hypothesis about positive effect of competition on bank soundness is rejected only in the case when competition is proxied by Lerner index. Using Boone indicator as a competition measure, the results are doubtful. Keywords: Bank stability, competition, Latvian banks. 1. INTRODUCTION Competition in the banking sector can bring significant benefits to the market players, national economy and society, but also can be a source of a potential instability due to the fact that competition forces banks to take more risk. Recent studies support the positive relationship between the level of competition and overall stability in the banking sector [1][2][3][4]. The World Bank’s view is that “competition in the banking system is desirable for efficiency and maximization of social welfare”. [5] In turn, OECD experts in the report “Bank competition and stability” examine the interrelationship between banking competition and financial stability, considering the experience from the recent global crisis. They conclude that “that competition can be both good and bad for stability.” [6] Considering that banks are the major players in the financial system of the Baltic States, in particular in Latvia, the studying of competition-stability relationship in the Latvian banking market can provide vitally important information to policy makers. The goal of the paper is to investigate the relationship between bank stability and competition in the banking market. The present study continues the research described in the previous paper that was aimed to investigate the relationship between concentration, competition and efficiency in the Baltic banking market. [7] However, the sample is limited with only Latvian banks, because the range of applied ratios is extended. Besides, the relationship between different indices used to measure competition is tested. The following hypotheses are tested in the current study: H1: There is a statistically significant relationship between different competition measures. H2: Competition in the Latvian banking sector has a positive impact on bank stability. To test the first hypothesis the authors perform a correlation analysis to identify the statistical link between competition and concentration ratios. Concentration in the Latvian banking sector is measured with Herfindahl-Hirschman Index (HHI) and concentration ratio (CR5). To measure competition Lerner index and Boone indicator are used. ISSN: 1690-4524 SYSTEMICS, CYBERNETICS AND INFORMATICS VOLUME 13 - NUMBER 2 - YEAR 2015 25