Competition, Credit Risk and Banks’ Franchise Value: Evidence from Kuwait and COVID-19 Policy Insights

Purpose: This paper investigates the franchise-value paradigm theory proposed by Keeley (1990) in relation to the competition-credit risk nexus in Kuwait’s banking sector before and during the COVID-19 pandemic. The study explores the theories of fragility hypothesis, stability, and the non-linear argument, which are subjects of controversy to assess the competitive behavior regarding credit risk. Study design/methodology/approach: Panel data techniques were utilized (OLS, Random and Fixed effects). We divided the sample into two periods: 2010-2019 and 2020-2021 to capture the impact of the external shock. Sample and data: The sample includes five commercial banks operating in Kuwait, with data sourced from annual reports spanning 2010 to 2021. Results: The findings support the “neutral view”, indicating that intensified competition among banks erodes banks’ franchise value and induces credit risk, as posited by the “fragility hypothesis”. Furthermore, higher concentration increases credit risk and insolvency, aligning with the too-big-to-fail and competition-stability notions (Boyd & De Nicolo, 2005; Mishkin, 2006). Notably, during the COVID-19 period, banks’ capital buffers succeeded in absorbing credit risk, nonetheless failed to diversify away from interest-income activities. Originality/value: The study contributes by examining competitive behavior and pricing strategies above marginal costs. It also explores the impact by considering a combination of bank-control variables such as banks’ capital, size, profitability, solvency, and diversification, in relation to competition dynamics and the presence of COVID-19. Research limitations/implications: These findings offer perceptions for policymakers towards dealing with the competition-stability nexus and provide a policy implication on how regulators ought to behave during financial turmoil.