Does higher bank concentration reduce the level of competition in the banking industry? Further evidence from South East Asian economies

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Abstract

The level of bank concentration has increased significantly in the Association of South East Asian Nations (ASEAN) due to structural reforms undertaken in the banking sector, raising concerns about its potential negative impact on bank performance. In this paper, we empirically test the impact of bank concentration on competition in ASEAN using several indicators. The evidence indicates that the increase in the level of concentration has reduced bank competition and this finding is robust to employing several alternative measures of concentration and competition and empirical models. We discuss the policy implications of the findings.

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:ω1Compj,t=ω0+ω1CIj,t+ω2log(n)j,t+λii=1nXi,t+τjj=1mZj+εj,twhere, Compj,tand CIj,trefer to the level of competition and concentration respectively for country “j” in time “t”; log(n)j,tshows logarithm of the number of banks for country “j” in time “t”; i=1nXi,tand j=1mZjrepresent 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

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