Profitability and Competition in Banking Markets: A Cross Country Approach
Horst Gischer, Otto-von-Guericke-University Magdeburg, and D. Johannes Jüttner Macquarie University, Sydney
The issue of the level of competition in banking markets has been the focus of attention for some time now at the theoretical level and a plethora of empirical investigations have been carried out on the topic. Despite these research efforts no unanimity exists with respect to a satisfactory model of banking competition, the available empirical results are often ambiguous, and the applied research methods differ significantly.
Researchers encounter numerous difficulties in their endeavour to model and measure competition amongst banks. First, banking markets may be delineated on a geographical basis, viewed from a retail or wholesale perspective, assessed within national boundaries or placed in the international context. In addition, banking and securities markets and activities become increasingly blurred. Second, the output of banks is multi-product in nature while most empirical studies regard bank output as homogenous. Third, the literature has failed so far to integrate market structure with competitive behaviour. Thus structure-performance and Rosse-Panzar type investigations exist side by side. Fourth, finding an appropriate proxy variable for market power in econometric investigations has turned out to be an elusive task. The widely used 3- or 5-bank concentration ratios provide conflicting signals about their impact on competition. Fifth, the increasing globalization of banking poses new challenges, not only to active participants in the banking business but also to academic research. It appears the literature is only slowly coming to grips with the ramifications of global competition in banking.
Our paper attempts to advance our understanding of issues concerned with the last two point. We employ a range of market power proxies to assess their impact on competition, including sovereign risk ratings, concentration ratios and Lerner ratios. Furthermore, our international database allows us to test hypotheses about competition on a global basis. The empirical research employs OECD Banking Profitability statistics on an aggregative cross-country basis. Several proxies for a countries’ level of competition are used to test for their impact on the profitability of the banking industries for nineteen countries. Despite severe data limitations our empirical estimates appear to support the notion of market power impacting on banks’ profitability.