Bank Competition: What is the Role of the Government? César Calderón (FPDCE), Maria Soledad Martínez Pería (DECFP), Mauricio Pinzón Latorre (FPDCE), Klaus

Bank Competition:What is the Role of the Government?

César Calderón (FPDCE), Maria Soledad Martínez Pería (DECFP), Mauricio Pinzón Latorre (FPDCE), Klaus Schaeck (Bangor University)

1. Motivation2. Key messages3. Measurement and trends in banking competition4. Banking competition and financial development5. Drivers of banking competition6. Additional background work for the Chapter7. Conclusions and policy implications

Roadmap

• Greater bank competition can:– Raise bank efficiency– Enhance access to financial services– Promote bank stability

• Quality of regulatory framework is key to guarantee:– Greater market contestability– Positive side effects from enhanced competition

• Government may play a role in enhancing competition by designing policies that:– Build a strong institutional framework – Guarantee market contestability

• Design of entry/exit policies, prudential regulation and supervision should shape incentive framework that minimizes excessive risk-taking in the face of greater competition.

2. Key messages

• Goal: Assemble a comprehensive array of indicators of banking competition.

• Data source: Bankscope• Three types of indicators– Structural measures (SCP paradigm): Market structure• Share of assets held by the k largest banks (k=3, 5)• Herfindahl-Hirschman index (assets- and loan-based)

– Contestability measures: ease of entry and exit• Requirements for bank licenses• Share of licenses denied

– Non-structural measures (New empirical IO): Market power• H-Statistic• Lerner Index

3. Measurement and trends in bank competition

• H-Statistic (Panzar & Rosse, 1982, 1987)– Elasticity of bank interest revenues to input prices– Greater values of H implies more intensive banking

competition (under certain conditions)– Valid only if market in long-run equilibrium

• Lerner Index (Lerner, 1934)– Divergence between prices and marginal costs– Not a long run equilibrium measure– We can build a time series

• Limitations of measures of competition– Structural features of markets irrelevant as long as markets

are contestable– Measures used are country-level, but competition may vary

by product and by markets, where markets may be defined at the state or country level

3. Measurement and trends in bank competition

3. Trends in competition: Market concentration

0.50

0.55

0.60

0.65

0.70

0.75

0.80

0.85

0.90

1996-10 2000-07 2000-10

Industrial Countries Developing Countries

Asset share of 5 largest banks (CR5)Industrial and Developing Countries

Source: GFDR Team’s calculation based on data from Bankscope. Median values across country groups are reported.

3. Trends in competition: Market concentration

Asset share of 5 largest banks (CR5)Across Developing Regions, 1996-2010 (Average)

Source: GFDR Team’s calculation based on data from Bankscope. Median values across country groups are reported.

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55

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AMER EAP ECA Non-GCC MENA GCC MENA SA SSA

3. Trends in Competition: Contestability

Barriers to EntryIndustrial vs. Developing Countries

Share of denied licensesIndustrial vs. Developing Countries

Note: The index of entry into banking requirements captures whether various types of legal submissions are required to obtain a banking license. Higher scores indicate higher restrictions on entry into banking. On the other hand, the share of denied licenses is the ratio of denied to total banking licensing requests. Source: Bank regulation and supervision survey (Barth, Caprio and Levine, 2001, 2004, 2006, 2012). Elaboration: GFDR Team.

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5

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25


2001 2010

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2001 2010

3. Trends in Competition: Contestability

Barriers to EntryBy Developing Regions

Share of denied licensesBy Developing Regions

Note: The index of entry into banking requirements captures whether various types of legal submissions are required to obtain a banking license. Higher scores indicate higher restrictions on entry into banking. On the other hand, the share of denied licenses is the ratio of denied to total banking licensing requests. Source: Bank regulation and supervision survey (Barth, Caprio and Levine, 2001, 2004, 2006, 2012). Elaboration: GFDR Team.

0

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AMER EAP ECA Non-GCC MENA

GCC MENA

SA SSA

2001 2010

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AMER EAP ECA Non-GCC MENA

GCC MENA

SA SSA

2001 2010

3. Trends in Competition: H-Statistic

H-Statistic: Industrial and Developing Countries

Note: H-Statistic figures are calculated for commercial banks based on data from Bankscope and following the methodology described in Demirguc-Kunt and Martínez-Pería (2010). Elaboration: GFDR Team.

0.40

0.45

0.50

0.55

0.60

0.65

1996-2007 2000-2007 2000-2010


3. Trends in Competition: H-Statistic

H-Statistic Across Developing Regions, 1996-2007

Note: H-Statistic figures are calculated for commercial banks based on data from Bankscope and following the methodology described in Demirguc-Kunt and Martínez-Pería (2010). Elaboration: GFDR Team.

0.0

0.1

0.2

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0.4

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Latin America

East Asia & the Pacific

Eastern Europe &

Central Asia

Non-GCC MENA

GCC MENA South Asia Sub-Saharan Africa

3. Trends in Competition: Lerner Index

Annual Evolution: Industrial vs. Developing Countries

Period averages: Industrial vs. Developing Countries

Source: GFDR Team’s calculation based on data from Bankscope following the methodology described in Demirguc-Kunt and Martínez Pería (2010).

Median Mean

Industrial 1996-2007 0.206 0.193Countries 2000-2007 0.213 0.200

2000-2010 0.209 0.193

Developing 1996-2007 0.218 0.195Countries 2000-2007 0.237 0.216

2000-2010 0.219 0.210

3. Trends in Competition: Lerner Index

Lerner Index Across Developing Regions


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0.35

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0.45

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0.55

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

LAC EAP ECA Non-GCC MENA GCC MENA SA SSA

3. Trends in Competition: Concentration vs. Competition

H-Statistic vs. CR5 Lerner Index vs. CR5


y = 0.0235x + 0.5703R² = 0.0004

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Concentration CR5

y = 0.2183x + 0.048R² = 0.1458

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Concentration CR5

• Bank competition can impact various dimensions of financial development such as efficiency, access, and stability.

• Efficiency – Alternative theories on the competition-efficiency nexus

• Quiet Life (Hicks, 1935) – without competition banks relax their efforts to control costs.

• Efficient Structure (Demsetz, 1973) – points to reverse causation between efficiency and concentration: more efficient firms are able to gain greater market shares.

– Studies focusing on direct measures of competition or contestability show that competition brings about efficiency improvements.• Developed countries (Schaeck and Cihak, 2011; Evanoff and Ors,

2008; Demirguc-Kunt et al. , 2004)• Developing countries (Lin, Ma and Song, 2010; Turk-Ariss, 2010)

4. Banking competition and financial development

• Access– Ambiguous theoretical prediction for competition-access link

• Market power hypothesis argues that competition in the banking market reduces the cost of finance and increases the availability of credit.

• Information hypothesis argues that, in the presence of information asymmetries and agency costs, competition can reduce access by making it more difficult for banks to internalize the benefits of investing in building lending relationships, in particular, with opaque clients (Petersen and Rajan, 1995; Marquez, 2002).

– Evidence between concentration and access yields mixed result.– But, studies using direct measures of competition find that

competition improves access (see Claessens and Laeven, 2005; Carbó et al. 2009).


• Stability– Competing theories explaining competition-stability relationship

• Competition-fragility view predicts that competitive banking systems are less stable, because competition reduces bank profits and erodes the charter value of banks, increasing banks’ incentives for excessive risk-taking (see Marcus, 1984; Chan, Greenbaum and Thakor, 1986; and Keeley, 1990).

• Competition-stability view argues that since in less competitive sectors banks can charge higher interest rates, this may induce firms to assume greater risk, resulting in a higher probability that loans become non-performing. Similarly, higher interest rates might attract riskier borrowers through the adverse selection effect (Boyd and De Nicoló, 2005).


• Stability.– Early country specific bank-level studies yield mixed results.– Three strands of recent studies provide evidence of positive link

between competition and stability.• Regulatory restrictions on bank entry and exit promote systemic

banking distress (Beck, Demirguc-Kunt and Levine, 2006 a, b)• Bank competition (H-Statistic) reduces systemic bank fragility

(Schaeck, Cihak and Wolfe, 2009)• Competition (Lerner index) is associated with greater systemic

stability (Anginer, Demirguc-Kunt, and Zhu, 2011).– OECD Competition Committee. Design and application of better

regulations (rather than competition policies) to promote banking stability.



Lerner Index Across Developing Regions

Source: High (low) competition is defined as the bottom (top) quartile of the country distribution of the Lerner index (country median across banks over the period 1996-2010). Elaboration: GFDR Team

0

25

50

75

100Depth

Efficiency

Stability

Access

High Competition Low Competition



Source: High (low) competition is defined as the bottom (top) quartile of the country distribution of the Lerner index (country median across banks over the period 1996-2010). Elaboration: GFDR Team

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25

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100Depth

Efficiency

Stability

Access


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100Depth

Efficiency

Stability

Access


• Cross-section analysis of the drivers of banking competition– Choice of drivers follows the literature (Claessens and Laeven, 2004;

Anzoategui, Martinez-Pería and Rocha, 2010; Demirguc-Kunt and Martínez-Pería, 2010, among others)

• Focus on the role of the State– As market participant.

• Presence of government-owned banks (GOBs)– As regulator.

• Entry barriers to the industry• Overall activity restrictions• Transparency and disclosure requirements

– As enabler of a market-friendly environment.• Overall strength of the institutional framework• Quality of credit information

5. Drivers of Banking Competition

5. Drivers of banking competition Contestability and Institutional Framework

Note: The dependent variable is the Lerner index for the country computed over the 1996-2010 period. Regressions were estimated using least squares with robust standard errors (White, 1980). Elaboration: GFDR Team

Variables [1] [2] [3] [4] [5] [6] [7]

Contestability - Entry barriers 0.0442** 0.0480** 0.0410** 0.0383** 0.0410** 0.0413** 0.0393**

[0.018] [0.019] [0.020] [0.019] [0.019] [0.020] [0.019] - Share of bank licenses denied 0.0129 0.0160 -0.0041 -0.0042 0.0004 -0.0072 -0.0062

[0.032] [0.032] [0.037] [0.035] [0.033] [0.035] [0.034] - Restrictions on bank activities 0.0045 0.0047 0.0022 0.0003 0.0008 -0.0005 -0.0017

[0.005] [0.005] [0.006] [0.006] [0.006] [0.006] [0.006] - Minimum entry capital required .. 0.0031*** 0.0033*** 0.0028*** 0.0031*** 0.0034*** 0.0031*** (in logs ) [0.001] [0.001] [0.001] [0.001] [0.001] [0.001]

Ownership - Government bank participation 0.0242 0.0255 0.0010 -0.0127 -0.0038 -0.0195 -0.0119

[0.048] [0.048] [0.048] [0.045] [0.044] [0.042] [0.042] - Foreign bank participation .. .. .. -0.0478 -0.0389 -0.0323 -0.0467

[0.029] [0.029] [0.028] [0.030]Macroeconomy and Institutional Framework - Real GDP per capita .. .. -0.0133* -0.0157** .. .. ..

[0.007] [0.007] - Rule of Law .. .. .. .. -0.0195* .. ..

[0.010] - Regulatory quality .. .. .. .. .. -0.0336*** ..

[0.012] - Control of corruption .. .. .. .. .. .. -0.0274**

[0.011]

Observations 80 80 80 80 80 80 80R-squared 0.056 0.063 0.097 0.125 0.115 0.152 0.148

Robust standard errors in brackets. *** p<0.01, ** p<0.05, * p<0.1

5. Drivers of Banking Competition Transparency and depth of credit information


Variables [1] [2] [3] [4] [5] [6] [7] [8]

Contestability - Entry barriers 0.0311* 0.0317* 0.0333* 0.0308* 0.0246 0.0239 0.0278 0.0229

[0.017] [0.017] [0.018] [0.018] [0.020] [0.020] [0.020] [0.020] - Share of bank licenses denied -0.0129 -0.0117 -0.0156 -0.0168 -0.0257 -0.0278 -0.0353 -0.0314

[0.036] [0.035] [0.036] [0.036] [0.038] [0.036] [0.038] [0.036] - Restrictions on bank activities 0.0013 0.0013 0.0004 -0.0008 0.0017 0.0017 0.0007 -0.0005

[0.005] [0.005] [0.005] [0.006] [0.006] [0.006] [0.005] [0.006] - Minimum entry capital required 0.0023** 0.0025** 0.0028*** 0.0026** 0.0020 0.0023* 0.0029** 0.0022* (in logs ) [0.001] [0.001] [0.001] [0.001] [0.001] [0.001] [0.001] [0.001]

Transparency and depth of credit information - Depth of credit information -0.0125** -0.0135** -0.0117** -0.0126** -0.0124** -0.0137** -0.0113* -0.0127**

[0.005] [0.006] [0.006] [0.005] [0.006] [0.006] [0.006] [0.006] - Bank auditing requirements .. .. .. .. 0.0106 0.0112 0.0091 0.0113 [0.018] [0.018] [0.018] [0.018] - Bank disclosure .. .. .. .. 0.0154 0.0181 0.0241 0.0166

[0.016] [0.016] [0.017] [0.016]Ownership - Government bank participation -0.0117 -0.0088 -0.0191 -0.0155 0.0017 0.0054 -0.0061 -0.0013

[0.042] [0.040] [0.040] [0.039] [0.051] [0.049] [0.047] [0.048] - Foreign bank participation -0.0471 -0.0406 -0.0357 -0.0473 -0.0422 -0.0313 -0.0206 -0.0390

[0.030] [0.030] [0.029] [0.031] [0.032] [0.031] [0.030] [0.033]Macroeconomy and Institutional Framework - Real GDP per capita -0.0109 .. .. .. -0.0158* .. .. ..

[0.008] [0.009] - Rule of Law .. -0.0157 .. .. .. -0.0259** .. ..

[0.011] [0.012] - Regulatory quality .. .. -0.0264* .. .. .. -0.0435** ..

[0.013] [0.016] - Control of corruption .. .. .. -0.0229* .. .. .. -0.0309**

[0.012] [0.012]

Observations 78 78 78 78 77 77 77 77R-squared 0.180 0.182 0.201 0.206 0.186 0.199 0.235 0.226Robust standard errors in brackets. *** p<0.01, ** p<0.05, * p<0.1

5. Drivers of Banking Competition Inter-industry competition and market structure


Variables [1] [2] [3] [4] [5] [6] [7] [8]

Contestability - Entry barriers 0.0308* 0.0316* 0.0347* 0.0308 0.0348* 0.0347* 0.0391* 0.0347*

[0.017] [0.018] [0.020] [0.019] [0.018] [0.020] [0.021] [0.020] - Share of bank licenses denied 0.0290 0.0288 0.0245 0.0223 0.0275 0.0233 0.0200 0.0138

[0.031] [0.030] [0.032] [0.031] [0.032] [0.031] [0.032] [0.032] - Restrictions on bank activities -0.0007 -0.0011 -0.0019 -0.0027 0.0010 0.0006 -0.0000 -0.0012

[0.006] [0.006] [0.006] [0.006] [0.006] [0.006] [0.006] [0.006] - Minimum entry capital required 0.0027*** 0.0030*** 0.0034*** 0.0030*** 0.0025** 0.0026** 0.0031** 0.0026** (in logs ) [0.001] [0.001] [0.001] [0.001] [0.001] [0.001] [0.001] [0.001]

Market Structure - CR3: Asset share of 3 largest banks .. .. .. .. 0.0318 0.0493 0.0502 0.0610

[0.042] [0.044] [0.044] [0.046]Inter-Industry competition - Stock market capitalization -0.0225 -0.0192 -0.0108 -0.0110 -0.0169 -0.0078 -0.0001 0.0054 (ratio to GDP) [0.022] [0.021] [0.019] [0.020] [0.022] [0.019] [0.017] [0.017]Ownership - Government bank participation -0.0635* -0.0609 -0.0643 -0.0666 -0.0565 -0.0528 -0.0558 -0.0582

[0.037] [0.040] [0.040] [0.040] [0.038] [0.041] [0.041] [0.042] - Foreign bank participation -0.0541* -0.0488 -0.0407 -0.0533* -0.0636* -0.0602* -0.0513* -0.0696**

[0.031] [0.030] [0.029] [0.031] [0.032] [0.031] [0.029] [0.032]Macroeconomy and Institutional Framework - Real GDP per capita -0.0090 .. .. .. -0.0102 .. .. ..

[0.009] [0.009] - Rule of Law .. -0.0157 .. .. .. -0.0216* .. ..

[0.011] [0.011] - Regulatory quality .. .. -0.0305* .. .. .. -0.0367** ..

[0.016] [0.017] - Control of corruption .. .. .. -0.0234* .. .. .. -0.0326**

[0.012] [0.013]

Observations 66 66 66 66 65 65 65 65R-squared 0.128 0.137 0.168 0.162 0.149 0.170 0.205 0.212Robust standard errors in brackets. *** p<0.01, ** p<0.05, * p<0.1

5. Drivers of Banking Competition: Explaining differences in the Lerner index vis-à-vis High Performer

Note: We report the explained differences in the Lerner index between the median values of the policy drivers for the selected developing regions vis-à-vis the higher performer in competition and its drivers. The high performer is computed as the top quartile of the overall sample distribution of the Lerner index and its determinants.

Explaining differences in Lerner relative to Top QuartileDeveloping Latin East Eastern Middle South Sub-SaharanCountries America Asia Europe East Asia Africa

Actual Difference in H -0.0498 -0.0101 -0.0565 -0.0187 -0.1114 0.0264 -0.0917

Contestability - Entry barriers -0.0046 -0.0046 -0.0046 -0.0046 -0.0046 0.0000 -0.0046 - Share of bank licenses denied 0.0043 0.0052 0.0005 0.0039 0.0052 0.0122 0.0062 - Restrictions on bank activities -0.0008 -0.0008 -0.0010 -0.0004 -0.0008 -0.0012 -0.0008 - Minimum entry capital required 0.0000 0.0000 -0.0008 0.0000 -0.0001 -0.0001 0.0000

Transparency and depth of credit information - Depth of credit information -0.0134 0.0000 0.0000 -0.0134 -0.0276 -0.0192 -0.0368

Ownership - Government bank participation 0.0032 0.0019 0.0063 0.0053 0.0020 0.0123 0.0018 - Foreign bank participation -0.0106 -0.0091 -0.0151 0.0000 -0.0147 -0.0149 -0.0106

Institutional Framework - Regulatory quality -0.0232 -0.0238 -0.0103 -0.0208 -0.0200 -0.0394 -0.0336

Unexplained Difference -0.0046 0.0211 -0.0315 0.0113 -0.0507 0.0768 -0.0134

5. Banking Competition: Australia

• Competitive dynamics altered by global financial crisis (GFC)

• Non-ADI lenders share loss in mortgage lending markets (securitization)

• Slower growth/ withdrawal of foreign banks’ operations

• Strong growth in deposits (supported government’s deposit guarantee)

• Rising use of long-term wholesale debt and reduced short-term exposure.

• Demand for deposits by ADI rather than short-term / long-term wholesale funding.

• Initiatives to improve competition• Securitization markets. Government

investment in RMBS (up to US$ 8 bn.)• Account switching package. Lift

impediments to customers’ ability to switch banks.

• Trade practices amendment Bill. It forbids the use of unfair terms in standard-form consumer contracts. Courts allowed to void unfair terms.

• National consumer credit protection reform (First phase)– Licensing regime for providers of consumer

credit and credit services.– Responsible credit conduct obligations– Expanded consumer protection through

special court arrangements.

5. Banking Competition: South Africa

• Banking Enquiry (Dec. 2006) initiated by the Competition Commission

• Focus:– Retail banking– Payment systems

• Disproportionate market power of Big 4 banks (despite not having 30+ % share in any product category)

• Very high cost structures (i.e. fixed and common costs)

• Product differentiation and price complexity are very high.

• Large information gaps• Low customer switching

• Policy recommendations• Purpose-designed regime for

regulating non-banks’ access to payments system

• Establish regulator to determine need to inter-change any card/EFT transaction and regulating relevant fees.

• Regulating penalty fees for dishonored debit orders

• Replacing current inter-bank pricing model for automated cash machines with direct charging model (e.g. AUS)

• Introduce account switching codes to reduce costs of switching providers.

• Anginer, Demirguc-Kunt and Zhu (2012)– Reassess bank competition - systemic stability nexus– Focus on systemic risk rather than risk of individual banks– Banks take on more diversified risks with greater competition,

and system is less vulnerable to shocks.– Institutional and regulatory environment has a direct effect and

an amplifying effect on systemic stability

• Calderón and Schaeck (2012)– Policymakers calling for increasing competition in the aftermath

of rescue operations during ongoing crisis (OECD, 2009; Independent Commission on Banking, 2011)

– Examine the effects of State interventions on banking competition

– Interventions: (a) blanket guarantees, (b) liquidity support, (c) recapitalization, and (d) nationalizations.

6. Additional background work for the Chapter

7. Conclusions and policy implications

• Government may play a key role in enhancing competition in the financial sector

• Government should set up and implement policies that:– Ensure greater market contestability

• Low barriers to entry and exit

– Promote deeper financial markets• Development of NBFIs

– Promote bank transparency• Role for market discipline

• Greater bank competition raises efficiency and soundness, and allows a more efficient resource allocation

• Competition per se does not generate financial instability in countries with robust institutional frameworks– Harmful if regulations allow for excessive risk-taking– Generous deposit insurance may elevate risk-taking incentives

Documents

Bank Competition: What is the Role of the Government? César Calderón (FPDCE), Maria Soledad Martínez Pería (DECFP), Mauricio Pinzón Latorre (FPDCE), Klaus