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.
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.
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.
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.
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.
