The Impact of Diversification and Competition on the Stability of Commercial Banks: A Study in Vietnam

- E/TA (Equity/Total Asset) is the ratio of equity to total assets of the bank.

- σROA is the standard deviation of net profit on TTS.

The Z-score reflects the stability of a bank which increases as profitability and capitalization increase, and decreases as earnings volatility is reflected in the standard deviation of ROA. Thus, the Z-score measures the probability of a bank defaulting when the value of assets falls below the value of liabilities.

The capitalization ratio (E/TA) is used to reflect the stability of the bank. According to the Basel Accord, banks should focus more and manage their capital to counter the risk of default. Berger et al. (2004) in building a credit model argued that equity plays a large role in banks with competitive credit activities, and the capitalization of the bank is measured by the ratio of equity to total assets with a higher ratio indicating a lower risk of bankruptcy of the bank.

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In addition to the Z-Score model that is widely used in most studies related to banking stability, Segoviano and Goodhart (2009) presented a method in the IMF Working Paper to measure the stability of commercial banks. In this report, the two authors present a set of linear and non-linear methods for assessing the stability of banks through changes in the banking system through the country's economic cycles. This method is used to analyze the stability of each specific bank associated with the impacts from the economy, which is to determine the probability of bank distress. To do this, the authors use two indices JPoD (Joint Probability of Distress) and BSI (The Banking Stability Index). The JPoD index represents the probability of distress of the banking system, while the BSI reflects the expected number of distressed banks. Thus, the higher the number of distressed banks, the more unstable the banking system. That is, bank stability is expressed in terms of the probability of bank failure.

Although there are many methods of measuring bank stability,

The Z-Score model of Mercieca et al. (2007) is widely applied.

in many empirical studies and is increasingly suitable for the characteristics of the banking system of most countries today. Due to its popularity as well as the advantages of flexibility and ease of calculating the indexes in the formula, while still fully reflecting the economic significance, the thesis uses this Z-Score model.

In addition, to assess the stability of commercial banks more comprehensively, the thesis also uses indicators to measure the business efficiency (HQKD) of banks. According to Peter S. Rose (2004), the nature of commercial banks can also be considered as a business enterprise with the goal of maximizing profits within the acceptable risk level. Therefore, the profit target is considered the top priority because high profits help banks preserve operating capital, expand the market and seek more and more profitable investment opportunities.

In their study on the efficiency of financial institutions, Berger and Mester (1997) argued that efficiency is estimated based on the input factors, output and business environment of those financial institutions. In addition, efficiency also depends on the approach chosen by the evaluator. Furthermore, Hughes and Mester (2008) also argued that the efficiency of banks depends on other factors such as: law, operating environment, ownership or politics of that country.

Thus, the business performance of commercial banks is understood as:

(1) It is the ability of a commercial bank to use limited input factors to produce maximum output products, that is, the commercial bank has the ability to maximize profits with minimum costs;

(2) Ensure that business operations are conducted within safe limits.

In general, based on the content reflecting the banking business performance, this can be considered one of the aspects that economists can consider when analyzing and evaluating the stability of commercial banks themselves.

Bank performance is usually measured by profitability. Studies on bank performance or profitability mostly focus on

Two main theories: Market Power Theory (MP) and Efficient Structure Theory (ES).

MP theory has two approaches: Structure-Conduct-Efficiency (SCP) theory and relative market power (RMP) theory. SCP argues that market structure determines firm behavior and behavior determines market outcomes such as profitability, technical innovation and growth. In particular, many industries with high concentration create behaviors that lead to poor economic outcomes, reduced output and monopoly prices (Bain, 1951). According to SCP theory, the more concentrated the banking market is, the higher the lending interest rate and the lower the deposit interest rate because the level of competition is reduced. Meanwhile, according to Berger (1995), companies with large market shares and differentiated products can exercise market power and earn non-competitive profits. For example, some large banks with brand advantages and product quality can increase product and service prices to earn more profits.

However, the ES theory argues that the relationship between market structure and firm performance is determined by firm performance, i.e. firm performance creates the market structure. Olweny and Shipho (2011) suggest that banks are more profitable because they are more efficient. Depending on the type of efficiency considered, the ES theory is proposed in two directions: With Al – Muharrami and Matthews (2009) X-Efficiency approach, more efficient firms often achieve higher profits and larger market shares, because they are able to minimize production costs at any given output. Meanwhile, Olweny and Shipho (2011) Scale-Efficiency approach, the above relationship is explained based on scale. Larger banks have lower production costs, thus higher profits (economies of scale).

In addition to the above two theories, Nzongang and Atemnkeng (2006) also proposed the Balanced Portfolio Theory to study bank profitability. This theory suggests that investors can minimize market risk for an expected return by creating a portfolio of

Accordingly, for banks, this desired investment portfolio is the result of decisions made by the bank's Board of Directors.

In summary, MP theory assumes that bank profitability is a function of market factors. Meanwhile, ES theory and portfolio theory assume that bank efficiency is influenced by internal efficiency and management decisions. Accordingly, many studies based on the above theories introduce a number of variables into the model to measure bank profitability, such as Olweny and Shipho (2011) which is a function of both internal and external factors. In addition, to explain the change in bank profitability, internal factors are analyzed based on the Camel framework and the set of financial soundness indicators according to IMF standards (Financial Soundness Indicators: FSIs).

The Camel analysis framework has been applied since 1970. This is a system for rating and monitoring the banking situation in the US. The Camels analysis framework includes six factors: Capital Adequacy, Asset Quality, Management, Earnings, Liquidity and Sensitivity to Market risk. There are many studies evaluating the factors affecting the profitability of banks in the world based on the Camels foundation such as the research of Uzhegova (2010), Olweny and Shipho (2011), ... and Camels is also proposed for use by the Banking Supervision Committee and the IMF (Baral, 2005).

Camels's Capital Adequacy Ratios:

Capital Adequacy Ratio (CAR)

Equity / Total Assets Ratio (ETA)

Equity / Debt Ratio (ED) Camels' suite of metrics for Asset Quality has:

Bad Debt Ratio / Total Outstanding Debt (NPL Ratio)

Net Loans / Total Assets Ratio (NL/TA)

Risk Provision / Total Outstanding Loan (LLA/NL)

Camels Index on Management:

Cost Management – Net Profit Margin (NPM)

Income Management, Asset Turnover - Asset Utilization (AU)

Credit growth rate

Camels Profitability Indicators

Return on Assets (ROA)

Return on Equity (ROE)

Net Interest Margin (NIM)

Interest Income Rate (IIR) Camels Liquidity Indicators:

Liquid Assets / Total Deposits Ratio (LA/TD)

Liquid Assets / Total Assets Ratio (LA/TA)

Loan to Deposit Ratio (LDR)

Camels Indicators of Sensitivity to Market Risk:

Regarding the set of financial soundness indicators according to IMF standards , developed and issued by the IMF, to help improve the financial system, as well as to provide early warning of potential risks and dangers to the financial system of member countries. There are about 12 core indicators for deposit-taking institutions and these are the most important basic indicators that the IMF has provided. These 12 indicators can be used to select variables for the banking performance assessment model. Specifically as follows:

Ratio of legal capital/Chartered capital compared to Total assets adjusted for risk by converted risk coefficient (Regulatory Capital to Risk-Weighted Asstes): This is the minimum capital adequacy ratio to measure whether the bank's ability to use capital is within the safety level or not.

Regulatory Tier 1 Capital to Risk -Weighted Assets: Is an indicator measuring the capital adequacy of a bank based on the core concept of Basel capital.

Nonperforming Loans Net of Provision to Capital: This is an indicator of a bank's capital adequacy, an important indicator of capital capacity against risks caused by bad debt.

Nonperforming Loans to Total Gross Loans: This index is considered as a representative unit to consider and evaluate the quality of bank assets. At the same time, this index is also used to determine the level of credit risk.

Sectoral Distribution of Loans to Total Loans: This is an indicator that assesses the quality of assets distributed across loans to residents and non-residents. This indicator reflects the level of diversity in the loan portfolio , thereby indicating whether the bank's financial situation is unstable or not.

Return on Assets (ROA): An index that reflects the level of efficiency in the bank's business through profits.

Return on Equity (ROE): An indicator measuring the efficiency of a bank's capital use through profits.

Interest Margin to Gross Income : Reflects the proportion of net interest income to the bank's total income.

Noninterest Expenses to Gross Income: This is a profitability ratio used to measure management costs relative to total income. It also assesses the efficiency of a bank's use of capital.

Liquid Assets to Total Assets: Liquid Asset Ratio: Measures the liquidity of assets. This ratio reflects the bank's ability to meet customers' demand for cash withdrawals.

Liquid Assets to Short -term Liabilities: An indicator of the balance between assets and liabilities. It also shows whether a bank's liquidity is affected by short-term customer withdrawals.

Net Open Position in Foreign Exchange to Capital: This index measures the bank's sensitivity to fluctuations: market exchange rate risk, showing the bank's ability to balance the position between foreign currency assets and foreign currency capital.

Thus, there are many criteria to evaluate the efficiency of banking business operations. Empirical studies show that economists always flexibly apply the indicators in the two sets of indicators above to achieve their research purposes. In this thesis, the author chooses the most basic indicators, namely ROA, ROE (Ariss, 2010; Uhde and Heimeshoff, 2009), Risk-adjusted profit RAR ROA , RAR ROE (Amidu et al., 2013, Vo Xuan Vinh and Tran Thi Phuong Mai, 2015) to represent the evaluation of business performance in particular and the stability of Vietnamese commercial banks in general. These are indicators that are in the two sets of indicators above, and are also the most commonly used in Vietnam in empirical studies as well as in practical management work at commercial banks.

ROA, ROE, RAR ROA , RAR ROE index according to the following formula:

Wife and Husband Wife and Husband

ROA =

Return on equity ROE = Owner's equity

RAR ROA

= 𝑅𝑂𝐴

𝜎𝑅𝑂𝐴

RAR ROE

= 𝑅𝑂𝐸

𝜎𝑅𝑂𝐸

2.3 Competition in banking activities

Banking stability is the ultimate goal of banking activities in any economy. In the current integration trend, to increase sustainable profits, banks always choose competition as the optimal method. Through that, banks build their image and trust with customers, expand their market share and improve their capacity in the international arena. Therefore, competition is considered the top concern in planning the stable development strategy of commercial banks today.

2.3.1 Concept

The term "Competition" is used frequently and quite popularly today in many fields, receiving much attention from scientists as well as

economics. From there, in each field, many different definitions and concepts are formed. Particularly in the business field, competition also has many diverse understandings, specifically:

According to K. Marx (1977): Capitalist competition is the fierce rivalry and struggle between capitalists to win favorable conditions in the production and consumption of goods to gain supernormal profits. When studying more deeply the nature of capitalist competition in capitalist commodity production, Marx argued that the basic law of competition is the adjustment of the average rate of profit between industries.

According to Michael E. Porter (1980): Competition is to gain market share. The nature of competition is to seek profits higher than the average profits that businesses have. The result of the competition process is the average profit in the industry in the direction of deep improvement leading to the consequence that prices can be reduced.

In addition, when referring to competition at the enterprise level, MEPorter (1996) explained that it is the struggle or struggle between competitors for customers, market share or resources of enterprises. The nature of competition in the new stage is not to destroy or exclude each other but to increase value or create more novelty and uniqueness for goods and services provided to customers. So that customers choose you instead of going to competitors. Later, in the book Competitive Advantage (1998), Porter affirmed the importance of competition in determining the success or failure of a company. He believes that competition helps determine the suitability in operations, thereby improving the efficiency of the company in some specific aspects such as: innovation, cultural cohesion, better operations, etc.

Another concept of competition was proposed by two economists PA Samuelson and WDNordhaus (1985): Competition is the rivalry between businesses to win customers or markets.

In summary, from many different perspectives and aspects, competition has the following characteristics: