Does the market discipline banks? Evidence from Balkan states

Abstract

PurposeThis research is designed to investigate the presence of market discipline in the banking sector, across Balkan states in Europe. Specifically, the effects of CAMEL variables on the cost of funds and deposit-switching have been assessed.Design/methodology/approachThe CAMEL method of bank evaluation has been applied as well as two measures for market discipline (costs of funds and deposit-switching behaviour). Data have been obtained for 10 Balkan states for the 2006–2019 period. For data analysis, ordinary least squares (OLS) and fixed effects models have been utilized. The generalized method of moments (GMM) method has been deployed as well as a dynamic panel model.FindingsEvidence of market discipline has been found, in the form of a higher cost of funds in the context of capital adequacy (but not for other CAMEL variables). Evidence of market discipline in the form of deposit-switching, however, has not been found. In addition, it has been discovered that bank size and gross domestic product (GDP) growth lower the costs of funds for banks.Originality/valueIn the wake of the pandemic, banks need to prepare themselves for very difficult situations and relevant studies can provide help. Therefore, this research has contributed to the developing literature on this topic. In addition, the findings have important practical implications. Results show that banks should maintain adequate levels of capital if they want to control their costs of funds. Results also show that market discipline, in the form of higher costs of funds, can be imposed on banks to discourage excessive risk-taking. Findings highlight the value of appropriate policies and strong supervision of the financial industry. Findings also underline the importance of offering financial incentives to banks. For example, if banks know they will be able to avoid higher costs of funds by controlling their risk levels, they will avoid unrestrained risk-taking.