Does higher bank concentration reduce the level of competition in the banking industry? Further evidence from South East Asian economies
Introduction
Whether higher bank concentration has a negative effect on the level of bank competition is a question of prime importance for anti-trust policy especially in the context of the Association of South East Asian Nations (ASEAN) as they have introduced significant structural reforms in their banking sectors since the Asian financial crisis of 1997–98 and the more recent global financial crisis of 2008–09 in order to strengthen the financial institutions against future financial crises. The areas of changes have included integration of financial markets, privatization and deregulation, a wave of mergers and acquisitions and other financial reforms. As a result, there has been an increase in the degree of financial markets in East Asia (Lestano & Kuper, 2016).
In addition, ASEAN governments have encouraged banks to implement mergers and acquisitions activities in order to further ensure financial stability in the region and also announced the so-called Banking Integration Framework (BIF) by 2020 to further liberalize the banking sector. A recent report by the Asian Development Bank highlights that BIF will lead to more consolidations in the domestic banking market in an effort to fortify domestic banks. Overall, these developments have increased the level of bank concentration over time. Fig. A1, Fig. A2 show an increase in the average values of different measures of bank concentration in ASEAN over the period from 1995 to 2014. At the same time, average values of nonstructural measures of competition in Fig. 3 (as reported in the appendix) suggest an increase in market power (i.e., decrease in level of competition) over this period. This move towards a concentrated banking system is likely to lead to more monopoly power over time raising concerns for policy makers. Hence, an important research question we address in this paper is whether the increase in bank concentration has had negative consequences for bank competition in the region.
The issue of competition in banking sectors becomes crucial for several reasons. Bank loans along with financial services act as an input in production of goods and services. If changes in market structure of banking industry cause inefficiency, this effect is directly/indirectly transferred to the economy. In addition, the link between bank concentration and competition is not clear cut and has therefore been subject to growing debate. Although high bank concentration is assumed to imply low level of competition under the structure-conduct-performance (SCP) paradigm, there is limited empirical evidence to support this notion. To the best of our knowledge, Bikker and Haaf (2002) and Claessens and Laeven (2004) are only the empirical studies that directly investigate the bank concentration-competition link. Bikker and Haaf (2002) report that a higher level of bank concentration is likely to reduce competition by generating a few large (cartel) banks that can restrict overall competition in the sector. On the other hand, Claessens and Laeven (2004) find that concentrated banking industries have higher degree of competition. In addition, Dell’Ariccia (2000) and Northcott (2004, pp. 2004–24) argue that bank competition can prevail even in highly concentrated markets. Beck, Demirgüç-Kunt, and Levine (2006) find that both the bank competition and concentration affect the banking system stability in a positive manner. Overall, there are some other studies (reviewed in details in the next section), argue a positive relationship between bank concentration and competition in the banking sector, which is in contradiction to the implications of SCP view.
Given the debate on the bank concentration and competition link and limited empirical evidence on it, we further investigate this issue for ASEAN. We focus on these economies due to recent reforms and structural changes undertaken in their banking sectors and results have significant implications for antitrust policy. To do so, we first estimate alternative concentration and competition measures to look into the structural characteristics of banking market for five ASEAN economies over the period of 1995–2014. We then use this data to explore the relationship between concentration and level of competition to test whether bank concentration has reduced the level of competition in the ASEAN banking industry.
For our analysis, we apply six alternative measures of bank concentration i.e. 5-bank concentration and the Hirschman Herfindahl Index based on assets, loans and deposits, and four alternative indicators of competition i.e. the conventional and adjusted Lerner Index, the Panzar-Rosse H-statistics and the Boone indicator. The results suggest that the level of competition is inversely related with bank concentration and the evidence is robust across alternative measures of concentration and competition, as well as different time horizons.
The study contributes towards the banking structure literature in three important ways. First, the SCP paradigm provides a theoretical relationship between market structure (concentration) and conduct (competition); however, this relationship has not been investigated much in the empirical literature.1 This study addresses this gap by using alternative measures of concentration and competition to further study the relationship. Second, few studies which examine structure-conduct relationship do so by applying only one or two measures of bank concentration and competition. For example, Bikker and Haaf (2002) and Claessens and Laeven (2004) use only the Panzar-Rosse model to infer the level of competition which can be problematic to infer strong conclusions.2 This study estimates and employs four alternative measures of competition and six concentration indices, providing more robust and most comprehensive estimates than previous studies. Third, the related literature in the context of ASEAN is limited.
The rest of the study is organized as follows. Section 2 discusses the related literature. Section 3 discusses the methodology and measurement of variables. In section 4 we report the empirical results while and section 5 concludes the paper with policy implications.
Section snippets
Literature review
Banking market structure has attracted significant attention from researchers and policy makers and several studies have highlighted the role of banking market structure in bank performance and efficiency, financial stability, monetary policy transmission, economic growth and firms’ access to credit.3
Methodological considerations
To model the relationship between bank concentration and competition, we follow earlier studies Bikker and Haaf (2002) and Claessens and Laeven (2004)) and estimate the following regression:where, and refer to the level of competition and concentration respectively for country “j” in time “t”; shows logarithm of the number of banks for country “j” in time “t”; and represent the bank and country level
Descriptive statistics
Descriptive account of concentration indices and competition measures for each country is reported in Table 2. These values not only provide an outlook of data set i.e. averages, standard deviation, minimum and maximum values, but also give a rough picture of the level of bank concentration and competition. The characteristics of the banking market in each country based on the average values of the bank concentration indices and competition measures are discussed in detail in the following
Conclusion and policy implications
In order to improve financial stability, several South East Asian economies have implemented significant structural changes in their banking industry since the Asian financial crisis and the global financial crisis of 2008–09, and these changes have resulted in a significant increase in bank concentration. An important research question we have addressed in this paper is whether the increase in bank concentration has reduced the level of competition in the ASEAN banking industries. Our results
References (94)
- et al.
Expected worsening or improving financial instability and the 2008 financial crisis
The North American Journal of Economics and Finance
(2013) - et al.
The effect of banking market structure on the lending channel: Evidence from emerging markets
Review of Financial Economics
(2013) - et al.
Bank concentration, competition, and crises: First results
Journal of Banking & Finance
(2006) - et al.
Competition, concentration and their relationship: An empirical analysis of the banking industry
Journal of Banking & Finance
(2002) Competition and the integration of the markets for banking and financial services
The North American Journal of Economics and Finance
(1998)- et al.
Cross-country comparisons of competition and pricing power in european banking
Journal of International Money and Finance
(2009) - et al.
Convergence in bank performance: Evidence from Latin american banking
The North American Journal of Economics and Finance
(2017) Bank competition, financial reform, and institutions: The importance of being developed
Journal of Development Economics
(2012)- et al.
Market power in cee banking sectors and the impact of the global financial crisis
Journal of Banking & Finance
(2014) - et al.
Bank competition and financial stability in asia pacific
Journal of Banking & Finance
(2014)
Competition in banking: A disequilibrium approach
Journal of Banking & Finance
Integration of banking and financial service: A critique
The North American Journal of Economics and Finance
Bank competition and monetary policy
Japan and the World Economy
Bank ownership, regulation and efficiency: Perspectives from the middle east and north africa (mena) region
International Review of Economics & Finance
Bank competition and monetary policy transmission through the bank lending channel: Evidence from asean
International Review of Economics & Finance
Does financial regulation affect the profit efficiency and risk of banks? Evidence from China's commercial banks
The North American Journal of Economics and Finance
Changes in ownership structure and bank efficiency in asian developing countries: The role of financial freedom
International Review of Economics & Finance
New issues in corporate finance
European Economic Review
Competition in banking and the lending channel: Evidence from bank-level data in asia and Latin america
Journal of Banking & Finance
Consolidation in banking and the lending channel of monetary transmission: Evidence from asia and Latin america
Journal of International Money and Finance
Financial markets and growth: An overview
European Economic Review
Collusion vs. Superiority: A monte carlo analysis
International Journal of Industrial Organization
Does bank market power affect sme financing constraints?
Journal of Banking & Finance
Banking conduct before the european single banking license: A cross-country comparison
The North American Journal of Economics and Finance
The panzar–rosse revenue test and market power in banking
Journal of Banking & Finance
Foreign entry and the Turkish banking system in 2000s
The North American Journal of Economics and Finance
The relationship between banking market competition and risk-taking: Do size and capitalization matter?
Journal of Banking & Finance
On the implications of market power in banking: Evidence from developing countries
Journal of Banking & Finance
A finite sample correction for the variance of linear efficient two-step gmm estimators
Journal of Econometrics
Evidence on the effects of bank competition on firm borrowing and investment
Journal of Financial Economics
The effects of local banking market structure on the banking-lending channel of monetary policy: Board of Governors of the Federal Reserve System (US)
Credit market competition and capital regulation
Review of Financial Studies
Competition and financial stability
Journal of Money, Credit and Banking
Some tests of specification for panel data: Monte carlo evidence and an application to employment equations
The Review of Economic Studies
The lending channel in emerging economies: Are foreign banks different?
IMF Working Papers
Relation of profit rate to industry concentration: American manufacturing, 1936-1940
The Quarterly Journal of Economics
Barriers to new competition: Their character and consequences in manufacturing industries
Industrial organization: Wiley New York
Bank regulation and supervision: What works best?
Bank regulation and supervision in 180 countries from 1999 to 2011
Journal of Financial Economic Policy
The profit-structure relationship in banking–tests of market-power and efficient-structure hypotheses
Journal of Money, Credit and Banking
Bank concentration and competition: An evolution in the making
Journal of Money, Credit and Banking
The efficiency cost of market power in the banking industry: A test of the “quiet life” and related hypotheses
Review of Economics and Statistics
Assessing competition with the panzar-rosse model: The role of scale, costs, and equilibrium
Review of Economics and Statistics
A new way to measure competition*
The Economic Journal
How (not) to measure competition
When is the price cost margin a safe way to measure changes in competition?
De Economist
Cited by (24)
Banking sector competition and firms’ financial constraints: Firm-Level evidence from developing economies
2023, Journal of International Financial Markets, Institutions and MoneyCompetition in dual markets: Implications for banking system stability
2022, Global Finance JournalCitation Excerpt :Although the traditional Lerner index has several advantages over other measures, it is limited because it is based on given profit and cost efficiency assumptions. The Lerner index may therefore not reflect the actual market power of banks (Khan, Kutan, Ahmad, & Gee, 2017). Alternatively, the efficiency-adjusted Lerner index considers the possibility that banks fail to fully exploit output pricing opportunities due to market power, unlike the conventional Lerner index that assumes full efficiency (Koetter et al., 2012).
Financial innovation and bank growth: The role of institutional environments
2020, North American Journal of Economics and FinanceCitation Excerpt :In contrast, Lozano-Vivas and Pasiouras (2014) argue that bank growth varies among countries with different levels of economic and financial innovation development. By inspecting the enforcement of financial reforms, Khan, Kutan, Ahmad, and Gee (2017) conclude that they actually harm bank growth. Bound by financial reforms during the Global Financial Crisis (GFC), banks in Southeast Asia are now encouraged to execute mergers and acquisitions, which have led to higher concentrations in banking markets and thus a negative impact on bank growth.
Mortgage asymmetric pricing, cash rate and international funding cost: Australian evidence
2020, International Review of Economics and FinanceCitation Excerpt :Total assets and home-loan shares of the Big-4 increased from 65.4% of total ADI assets and 74% of total residential housing loans in October 2008 (pre-mergers) to 78.5% and 90% respectively in July 2009 (post-mergers).9 As a consequence, the increased market power of the Big-4 in the GFC aftermath creates their oligopolistic competition (Khan et al., 2017), allowing them to profit from their mortgage borrowers (Davis, 2011). The collapse of the residential mortgage-backed security (RMBS) market, which provided a relatively cheap source of funding for the ADIs before the crisis, enables the four largest banks to successively take advantage of smaller banks by increasing their share of new home loans.
Bank risk, competition and bank connectedness with firms: A literature review
2020, Research in International Business and FinanceCitation Excerpt :Using the frontier analysis, Bolt and Humphrey (2015) come to the same conclusion that these measures cannot be used interchangeably. More concentrated banking market may lower bank competition (Khan et al., 2017), but, in the same time, may provide a better access to bank deposits and loans (Owen and Pereira, 2018). Hence, one should be careful on the concept of competition one applies, since it is an important factor on banks’ financial results and behaviour.
Bank competition and regional integration: Evidence from ASEAN nations
2018, Review of Development FinanceCitation Excerpt :The coefficient of the concentration measure, although it is significantly affect H-Statistic, but it affects the H-Statistic in a positive way, which means that the more concentrated banking systems are more competitive. This result differ from the previous literature, which indicates that an increase in concentration impairs competition (Bikker and Haaf, 2002; Khan et al., 2017a). Similar to our result, Claessens and Laeven (2004) find a positive and statistically significant relationship between concentration measure and H-Statistic.