Does competition drive profitability? Evidence from EAC banks on credit risk and cost efficiency effects

Purpose This study examines the mediating role of credit risk-taking in the relationship between bank competition and profitability, and examines whether cost efficiency (CEF) moderates the effect of competition on credit risk-taking and on profitability. Design/methodology/approach Using panel data from four East African Community (EAC) countries between 2002 and 2022. To address endogeneity, the analysis employs instrumental variable two-stage least squares. Findings The results are threefold. First, bank competition reduces credit risk-taking, while credit risk-taking negatively affects profitability, supporting the competition–stability paradigm. However, competition itself shows no direct influence on profitability. Second, CEF does not exhibit a direct causal relationship with credit risk-taking, but its interaction with competition amplifies risk-taking behavior. Third, CEF negatively affects profitability, but its interaction with competition has no significant impact on bank performance. Research limitations/implications The findings suggest that although competition lowers credit risk-taking, it does not directly enhance profitability. Higher risk-taking reduces profitability, highlighting the need for stronger credit underwriting standards and anti-competition safeguards. Furthermore, while CEF may increase risk-taking, it also weakens profitability, implying that cost-cutting measures should not compromise prudent risk management. Regulators should therefore balance competitive intensity with financial stability to sustain the banking sector's resilience. Originality/value This study contributes to the banking literature by developing and testing a moderated–mediation framework that links competition, credit risk-taking, CEF, and profitability. It uniquely examines the moderating role of CEF on credit risk-taking, which simultaneously mediates the competition–profitability relationship–an area that has received limited empirical attention, particularly in the EAC context.