Market concentration, asset allocation in banking: implications for financial stability and competitive dynamics

Abstract

This study examines the relationship between market concentration and asset allocation in the banking sector, with a particular focus on the Albanian banking industry. Using the Herfindahl-Hirschman Index (HHI) as a measure of market concentration, we analyze how banks allocate their assets between traditional lending and investments in government securities. The findings indicate a growing preference for risk-averse investment strategies, particularly among large banks, which raises concerns about the decline in credit intermediation and its implications for profitability, systemic stability, and economic growth. The study also highlights the risks associated with excessive investment in sovereign debt, including interest rate risk, sovereign-bank nexus vulnerabilities, and reduced net interest margins (NIMs). The empirical analysis, based on HHI calculations for the Albanian banking sector, suggests that despite moderate market concentration, a small number of banks hold a dominant share of assets, deposits, and government debt financing, leading to potential systemic risks. The findings underscore the need for balanced asset allocation strategies, enhanced risk management frameworks, and regulatory incentives to promote sustainable lending practices. This research contributes to the ongoing discourse on banking sector competitiveness, financial stability, offering policy recommendations to ensure banks maintain their core function as credit intermediaries while navigating regulatory and market challenges