Effect of Liberalization on Banking Competition

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1 Effect of Liberalization on Banking Competition Gloria O. Pasadilla Melanie S. Milo Philippine Institute for Development Studies 27 June 2005

2 GENERAL: THE PROBLEM assess the effects of competition policy reforms on bank competition SPECIFIC: 1. evaluate impacts of reforms on concentration 2. evaluate impacts of profitability and margins 3. measure actual degree of competition: H-stat 07/20/2005 Slide # 2

3 THE CONTEXT Major reforms in 1990s Easing of restrictions on domestic bank entry and branching Foreign Entry (RA No. 7721) Consolidation trend Asian crisis 07/20/2005 Slide # 3

4 THE CONTEXT Past findings Foreign entry leads to: greater efficiency reduced interest margins improved competitiveness reduced profits Market concentration is positively (negatively) associated with profits (efficiency) 07/20/2005 Slide # 4

5 Effect on the Number of Banks domestic, 10 foreign banks entered 6 bank mergers Total banks Foreign banks 07/20/2005 Slide # 5

6 Effect on Performance of Philippine Banks (Percent of Total Assets) Net Interest Income Non Interest Income Bad debt expenses Tax Profit After Tax Source of Basic Data: Securities and Exchange Commission 07/20/2005 Slide # 6

7 Comparison with other ASEAN (Percent of Total Assets, ) RP Indonesia Thailand Profit after Tax Overhead/Asset Source of Basic Data: Securities and Exchange Commission 07/20/2005 Slide # 7

8 Effect on Margins Bank Average Lending Rates, Savings and Short-term Deposit Rates and Bank Interest Spread Bank Average Short-Term YEAR Lending Rate 2 Savings 1 Time Deposits Bank Spread (1) (2) (3) (1-2) (1-3) Source: BSP SPEI, BSP Statistics online. 07/20/2005 Slide # 8

9 Effect on Margins By Type of Banks 9.00% 8.00% 7.00% 6.00% 5.00% 4.00% 3.00% 2.00% Universal Banks All banks UB 07/20/2005 Slide # 9 KB FB GB

10 Effect on Market Concentration Left scale Asset Share Herfindahl Right scale Top 5 Bottom 20 HI Left scale /20/2005 Slide # 10

11 Measuring Competitiveness - Problems with other methods margins affected by many other factors no exact benchmark for competitive returns - Alternative Method - Structural or contestability approach e.g. Panzar-Rosse Method 07/20/2005 Slide # 11

12 Contestability Literature short excursion - S-C-P Paradigm does not always hold threat of entry can enforce competition despite degree of concentration - e.g. US and Canadian Banking market conversely, collusive action can exist even when there are many firms - e.g. small banks in EU countries 07/20/2005 Slide # 12

13 Contestability Literature short excursion - No definitive relationship between market concentration and degree of competition Some found evidence that concentration impairs competitiveness (Bikker and Haaf, 2001) degree of competition unrelated to market structure. Contestability and market openness affects competition more (Claessens and Laeven, 2003). 07/20/2005 Slide # 13

14 AlternativeMeasure of Competitiveness: H statistic - H-stat = sum of revenue elasticities with respect to changes in input prices - Regression of revenue on input prices and other variables that shift either demand or supply of loans H 0 collusive oligopoly or monopoly H=1 perfect competition 0<H<1 monopolistic competition 07/20/2005 Slide # 14

15 Models: 1. reduced form equation of revenue 2. tried different dependent variables: total income and income from loans Period: Data: 1. financial statements of individual banks from BSP and SEC; others from NSCB 2. combination of time series and cross-section data 3. used both unbalanced data and balanced ( ) 07/20/2005 Slide # 15

16 MAJOR FINDINGS 1. Banking sector is fairly competitive 2. Competition in Loans business is more intense than fee generating business 07/20/2005 Slide # 16

17 Table 7. H-Statistics for Philippine Banking Sector (standard errors in parentheses, full sample regression) Dependent Balanced Unbalanced Variables Panel Panel 1.a. Number of Observations Full Period OLS 1.b. Total Income C C (0.070) (0.039) 1.c. Loan Income C C (0.080) (0.065) 2. With Fixed Effects 2.b. Total Income MC C (0.070) (0.049) 2.c. Loan Income C C (0.090) (0.073) 3. With Both Fixed Effects and Time Dummies 3.b. Total Income MC C (0.060) (0.055) 3.c. Loan Income C C (0.130) (0.087) 07/20/2005 Slide # 17

18 Change in Competition over Time Time Varying H-statistic (using full sample) Unbalanced panel Balanced panel Herfindahl Full - Total Income Full- Loan Inc Totinc loaninc Herfindahl 07/20/2005 Slide #

19 Figure 3. Time Varying H-statistic (using full sample) Totinc loaninc Full - Total Income Full- Loan Inc Herfindahl Source of basic data: PDIC. Note: a Yield on loans = Interest income from loans/average current loans 07/20/2005 Deposit cost = Interest expense on deposits/average current deposits Slide # 19

20 MAJOR FINDINGS 3. Increase in competition among small banks and decrease in competition among big banks 4. Increase in competition among commercial banks and decrease in competition among universal banks 5. Increase in competition among merged banks 07/20/2005 Slide # 20

21 Figure 4. Time Varying H-statistic (Top 10 vs. Non Top 10) Non-Top Full - Total Incom e T10 - Total Incom e NT10 - Total Incom e 0.4 Top /20/2005 Slide # 21

22 Figure 5 Time Varying H-statistic (Universal vs. Commercial Banks) Ordinary Commercial Universal Banks Full - Total Incom e Univ - Total Inc Commercial - Total Inc /20/2005 Slide # 22

23 Figure 6 Time Varying H-statistic (Merged vs. Not Merged Banks) Merged Banks Non-Merged Banks Full - Total Incom e Merged - Total Inc Not - Total Inc /20/2005 Slide # 23

24 Summary Herfindahl index points to no undue concentration Sector characterized by few large banks and many small banks on the fringe Entry of more market players are correlated with drop in interest spread and profit, possibly due to dissipation of previous monopoly profits 07/20/2005 Slide # 24

25 Summary H-stat disclose no monopoly or collusive behavior. Fairly competitive environment exists. Trend shows increased banking competition in latter 1990s. Competition is more intense in loan business than in feegenerating services. Big banks show competition decline and are more monopolistic competitors, small banks are more competitive. Much of the increase in competition was due to presence of small banks 07/20/2005 Slide # 25

26 PIDS Research Papers can be downloaded at: 07/20/2005 Slide # 26

4 CONCENTRATION AND COMPETITION IN THE BANKING SYSTEM 1

4 CONCENTRATION AND COMPETITION IN THE BANKING SYSTEM 1 While the banking sector in Pakistan is widely acknowledged for its rapid progress in recent years, debates still abound about the concentration