Testng for Competton n the Jamacan Bankng Sector: Evdence From Bank Level Data 1 Denvl Duncan Fnancal Stablty Unt Bank of Jamaca Abstract Ths paper presents an emprcal assessment of the market structure of the Jamacan bankng sector over the last thrteen years. Ths exercse s especally relevant gven the sgnfcant consoldaton trend n the bankng sector followng a fnancal crss durng ths perod. The ncrease n market concentraton has sgnfcant mplcatons for the level of competton as well as the welfare of the customers n the bankng sector. In contrast to the structural model of competton, the non-structural model does not support the hypothess of a sgnfcant postve mpact of fnancal lberalzaton on bank competton. However, both models strongly reject the hypotheses of monopoly/perfect colluson and perfect competton/contestable market n favour of monopolstc behavour (albet declnng competton) over the sample perod. 1 Denvl Duncan s a graduate student n the Department of Economcs, U.W.I, Mona Campus, Kngston, Jamaca Ths paper was wrtten whle Denvl Duncan served an ntern n the Research and Economc Programmng Dvson at the Bank of Jamaca. The vews expressed are those of the author and does not necessarly reflect the poston of the Bank of Jamaca.
1.0 Introducton Snce the early 1990s, the Jamacan bankng sector has experenced sgnfcant structural changes stemmng from a dsorderly fnancal lberalzaton process, whch preceded a severely dsruptve fnancal crss. As such, the last decade has mportant lessons n regard to factors nfluencng the relatonshp between competton and concentraton, whch has been unexplored. Ths paper ams to nvestgate the mpact of the recent structural changes on the degree of market power, and hence, consumer welfare, wth the ntenton to recommend an ntal framework that may be used by polcymakers n ther assessment of the level of competton, as well as ther regulatory decsons n regard to proposed mergers and acqustons n the bankng sector. Followng the shft towards a lberalzed Jamacan economy n the late 1980s, the fnancal market, ncludng the controls on the nterest rate and the captal account, was deregulated n the early 1990s. However, as was common wth many lberalzng economes at the tme, ths regme commenced wthout the necessary strengthenng of the regulatory and legal framework. As a consequence, there have been sgnfcant changes n the structure of the bankng sector over the past decade. Durng the post lberalzaton perod, the asset sze of the bankng sector recorded an average annual growth rate of approxmately 45.6 percent wth the hghest annual growth rate of 70 percent recorded at the end of 1992 (mmedately followng lberalzaton). 2 The dramatc expanson of the sector n the early 1990s culmnated n a fnancal crss n the latter part of the decade when steps were taken by the monetary authortes to stablze the economy. Indgenous banks were partcularly hard ht. At the end of the crss, sgnfcant changes occurred both n terms of the number and the ownershp structure of the bankng sector. The Bank of Jamaca (BOJ) has made strong efforts to encourage competton wthn the bankng sector, ncludng sgnfcant reductons n the lqud assets requrements 3 (whch began just pror to the commencement of the fnancal crss), and moral suason. Although concentraton has ncreased, ts explct mpact on competton n the bankng sector remans an mportant polcy queston. The crss perod that started n 1996, engendered dramatc reversals n the growth of the bankng sector, ncludng a sgnfcant fall n the rate of growth of total bank assets to an average of 12.5 per cent. Another reversal was the marked reducton n the number 2 See Table 1. 3 See Table 1. 1
crss. 5 Durng the crss, almost all of the ndgenous banks were defacto nsolvent. These banks of banks between 1996 and 1999. At the end of 1989, there were eleven banks n operaton. 4 Ths number fell to nne at the begnnng of the crss perod and subsequently to sx at the end of the were subsequently closed followng the Government s formaton of the Fnancal Sector Adjustment Company (FINSAC) n 1997 to resolve the severe problems n the fnancal system. FINSAC later spearheaded the merger of the four faled ndgenous banks, brngng the number of banks n the market to sx at the end of 1999. After the merged bank was sold to a foregn bank by FINSAC n 2000, the sector fnally settled n 2002 wth the sale of another bank by FINSAC to another foregn company. See Table 1 for detals on the changes n the bankng sector between 1989 and 2002. An mportant observaton of the perod under revew s that the major player n the bankng sector durng the crss perod was the Government through the operatons of FINSAC. Ths nfluental nvolvement of the Government nstead of pure market forces s consstent wth earler studes, whch reported that authortes n emergng markets typcally played a greater role n the resoluton of fnancal crses. 6 The ssues outlned above rase mportant polcy questons. For nstance, dd the ncreased concentraton n the Jamacan bankng sector lead to a reducton n competton, and thus negatvely affect consumer welfare? Alternatvely, dd the ncreased bank concentraton result n greater effcency n the sector? For example, accordng to recent theoretcal research on competton n fnancal systems, ncumbents wth large market shares may be forced to behave compettvely n order to prevent potental market entry. Also, what was the precse mpact of the Government nterventon n the sector on competton durng and after the crss? Ths paper attempts to answer these questons by conductng an extensve emprcal examnaton of the sample perod March 1989 to March 2002. Although studes have been carred out on the proftablty and effcency of the Jamacan bankng sector for the1990s, 7 the possble mpact of lberalzaton or the fnancal crss on the 4 Ths ncluded eght domestc and four foregn banks. The eght domestc banks ncluded: Natonal Commercal Bank (NCB), Workers Savngs and Loans (WSL), Trafalgar Commercal Bank (TCB), Eagle Commercal Bank (ECB), Mutual Securty Bank (MSB), Century Natonal Bank (CNB), Ctzens Bank (CBL). The four foregn banks ncluded: Bank of Nova Scota (BNS), Canadan Imperal bank of Commerce (CIBC), Bank of Credt and Commerce Internatonal (BCCI) and Ctbank (CBNA). 5 Fve foregn-owned and one domestcally-owned. 6 Such as Gelos and Roldos (2002). 7 See Stennet, Bachelor and Foga (1999), Green (1999), and Panton (1998). 2
level of market power n the bankng sector has remaned unexplored. Ths paper seeks to examne ths mpact by usng two competng methodologes. Frst, the Herfndahl-Hrschman Index (HHI), whch s the most common measure of concentraton, s calculated over the sample perod. Then, as a result of the shortcomngs of the HHI, ths study utlzes a more robust methodology put forward by Panzar and Rosse (1982 and 1987). The Panzar and Rosse methodology s appled usng a panel data set ncludng the entre populaton of commercal banks throughout the sample perod, whch allows the bankng sector to be analyzed for any changes n compettve behavour over tme. Followng ths ntroducton secton, secton 2 gves an overvew of the ssues nvolved n the lterature. The HHI s dscussed n secton 3. The Panzar-Rosse methodology s examned n secton 4. A descrpton of the data set s done n secton 5. Emprcal results are presented n secton 6 and secton 7 concludes. 2.0 Summary of the Relevant Lterature There s a vast academc lterature on the measurement of competton n the bankng sector. Ths feld s not wthout debate at both the theoretcal as well as the emprcal levels. Currently, there are two major approaches that may be used to evaluate the level of market power wthn a partcular sector. These approaches dffer accordng to whether the underlyng model of the sector s structural or non-structural. 8 The structural approach uses concentraton ratos, such as the Herfndahl-Hrschman Index, to form hypotheses about the relatonshp between concentraton and market structure. 9 In the case of a monopoly, when one frm has 100 per cent of the market share, the HHI wll be equal to 10,000, whch s the upper bound. The lower bound of zero s attaned when the market s perfectly compettve. Therefore, the larger the HHI, the more concentrated the market becomes, snce fewer frms control more of the market. However, the relatonshp between concentraton and market structure has been an area of consderable debate among the 8 See Bkker and Haaf (2001) 9 The HHI s calculated as the sum of the squared market shares of all the banks n the sector. That s = k 2 HHI MS, where MS s the bank s = 1 k market share and represents the number of banks n the sector. As an example, f the bankng sector ncluded 4 banks wth market shares of 60, 20, 15 and 5 per cent, then HHI 2 2 2 2 = 60 + 20 + 15 + 5 = 4250. If the latter 3 banks merged, then HHI 2 2 = 60 + 40 = 5200, ndcatng an ncrease n concentraton. 3
Structuralsts. The dscourse s centred on two competng hypotheses: the structure-conduct performance (SCP) hypothess and the contestablty hypothess. The SCP hypothess asserts that there exsts a non-lnear ncreasng relatonshp between concentraton and market power. 10 That s, as the market becomes more concentrated, the banks tend to collude and act as a monopoly n settng prces above the compettve level. Ths mples that there s an nverse relatonshp between concentraton and consumer welfare. Alternatvely, the contestablty hypothess suggests that even n the face of ncreased concentraton, ncumbent banks may stll behave compettvely once there exsts a potental free entrant who can offer smlar servces at lower costs. 11 It has further been argued that the postve relatonshp between concentraton and market power may be the result of the ncumbent banks beng forced by a hypothetcal entrant to ncrease ther market share by lowerng the prce of ther products (to equal cost, n the case of perfect contestablty ) rather than explot ther effcency advantages. Ths vew mples that greater concentraton may lead to a hgher level of consumer welfare. As a result of the present ambguty, efforts have been made to test the relatonshp emprcally. However, the fndngs are stll ambguous. Whle Berger and Hannan (1989) found evdence to support the SCP paradgm, Jackson (1992) found the relatonshp to be nonmonotonc and even negatve for hgh levels of concentraton, whch contradcts the SCP. 12 Furthermore, other studes have been nconclusve and have also been refuted on techncal grounds. 13 Apart from the ambguty surroundng the HHI theory, there are addtonal areas of concern. One mportant shortcomng s that whle the ndex accounts for the number of banks and ther market share, t does not consder the dstrbuton of the shares as well as the geographcal locaton of the banks. Ths makes comparsons wth other countres dffcult, as two countres could have the same HHI but dfferent market structures due to the dstrbuton of market shares. 14 The nablty of the structuralsts to clearly defne the relatonshp between concentraton and market power has prompted the search for non-structural models by the New Emprcal 10 See Cetorel (1999) for further dscusson. 11 See Baumol (1982). 12 See Cetorell (1999). 13 See Shaffer (1993). 14 See Cetorell (1999) for a dscusson. 4
Industral Organzaton (NEIO). These models, whch nclude those of Bresnahan (1982) and Panzar and Rosse (P-R) (1982 and 1987), do not rely on explct nformaton about market structure n order to determne the level of competton. 15 The Bresnahan methodology s executed by usng a smultaneous equaton model to estmate a system of equatons nvolvng the supply and demand functons as well as a prce equaton. From the estmaton, an ndex, measurng the extent of the frms market power, s developed. Usng ths methodology, Shaffer (1993) rejected the hypothess of monopoly/colluson n favour of perfect competton n the Canadan bankng sector, whle Nakane (2001) found the Brazlan bankng sector to be hghly, though not perfectly, compettve. The P-R model provdes a very smple approach to test the market structure of an ndustry for compettveness. Inferences are made based on the H-statstc, whch s calculated as the sum of the factor prce elastctes estmated from a reduced-form revenue functon. Use of the reduced-form revenue equaton elmnates the problems usually encountered when tryng to obtan supply sde nformaton. Ths s due to the fact that revenues are more lkely to be recorded than the cost data necessary to execute the Bresnahan approach. Addtonally, the Bresnahan approach reles on aggregated data, and thus, does not account for bank heterogenety. Alternatvely, when ndvdual bank data are avalable, the P-R approach may be preferred. An mportant advantage of the non-structuralst models s that they usually yeld smlar results when appled. 16 Ths s due prmarly to the fact that they have clearly defned hypotheses wth specfc nterpretatons. Therefore, there s lttle or no room for ambguty as s the case wth the structuralsts that have three potental explanatons for the one relatonshp. 3.0 The Herfndahl-Hrschman Index The Herfndahl Hrschman Index s a smple but useful tool for the measurement of concentraton wthn an ndustry. It s calculated as the sum of all the banks squared market shares, where market share may be based on ether deposts or assets. Although the relatonshp between the HHI and concentraton s clear, the lnk between concentraton and market power remans an ssue of much debate. As such, ths paper consders all the relevant arguments as 15 See Bkker and Haaf (2001). 16 See Shaffer (1993) and Nathan and Neave (1989). 5
outlned n secton 2 n order to explan the HHI emprcal results usng the Jamacan bankng data. A quarterly HHI was calculated for both deposts and assets over the perod January 1989 to March 2002. Both ndces dsplayed very smlar movements over the sample perod as shown n Fgures 1 to 3. A slow declne n each ndex was observed for the 1992 to 1995 postlberalsaton perod when the sector was expandng rapdly. Specfcally, both ndces declned below the 2000 mark durng the lberalzaton perod and the begnnng of the post lberalzaton perod, before movng above ths threshold n 1995. Accordng to the SCP approach, the declne mples ncreased competton among the banks followng fnancal lberalzaton. The year 1996 ended wth the ext of two banks that had a combned market share of approxmately 16 per cent. One of the extng banks merged wth a large bank n 1996, resultng n an ncrease n the latter s market share by approxmately 32 per cent. The market share of the other extng bank was dstrbuted across the market. These developments resulted n an unprecedented ncrease n the ndces by approxmately 40 percent, 17 ndcatng that the market became more concentrated and possbly less compettve. Subsequently, the HHI mldly fluctuated around the value of 3000 for assets, and 3250 for deposts as consoldaton n the sector contnued through the crss and post crss perods. An mportant observaton of the analyss s that the merger of four faled banks n 1999 dd not have a sgnfcant mpact on the ndces. A possble explanaton comes from an analyss of the market shares owned by these banks. Together the four banks owned only 15 percent of the total market share. Thus, after ther merger, there was a relatvely small change n bank concentraton. As a result, t s possble to conclude usng the HHI that the Jamacan bankng ndustry declned n compettveness throughout the sample perod manly as a result of the large merger n 1996. Another mportant observaton from the structural ndces revealed that the market shares of the two most domnant players drove ts pattern and movement over the entre sample perod. 18 Ths means that some form of olgopolstc behavour may characterze the market. For example, t could be the case that the two most domnant players are prce setters and the others are followers,.e., the market may be one of prce leadershp. 17 The ndex moved from 2100 to 3250 between June 1996 and December1996. 18 See Fgures 1 to 3. 6
It must be noted that the above analyss was based on the conventonal SCP paradgm, whch narrowly assumes that the relatonshp between concentraton and market power s postve. However, as outlned n secton 2, the nature of ths relatonshp s nconclusve usng the structural approach. To overcome ths problem, an emprcal analyss was carred out usng the Panzar-Rosse methodology descrbed n the followng secton. The use of the P-R model should clarfy ths uncertanty, snce the P-R model has clearly defned hypotheses to dstngush one market structure from another. 4.0 Emprcal Methodology Ths secton outlnes the model developed by Panzar and Rosse (1982 and 1987). Ther model uses ndvdual bank data to estmate a reduced-form revenue equaton. The nature of competton n the sector s evaluated usng the H-statstc the sum of the factor prce elastctes obtaned from the estmaton. Two crtcal mplcatons exst for ths equlbrum model. Frst, at the bank level, proft s maxmzed where margnal revenue s equal to margnal cost: / R ( y, κ, v ) C / ( y, f, q ) = 0 (1) / R s the margnal revenue functon, C s margnal cost functon, y s the output of bank, / s the number of banks, v and q conssts of exogenous varables that shft the bank s revenue and cost functons, respectvely, and f s a vector of bank s factor nput prces. The second mplcaton s that the zero proft constrant holds at the ndustry level: 19 κ * * * R ( y, κ, v) C * ( y *, f, q) = 0 (2) From these condtons, the H-statstc s formulated as: 20 19 * ndcates equlbrum values. 20 See Panzar and Rosse (1987) for further dscusson. 7
t * R f x Η = (3) * f R x = 1 x Ths s the sum of the factor prce elastctes, whch ndcates how responsve revenue s to a percentage change n factor prces. Before outlnng the estmaton procedure t s necessary to dscuss the varous testable mplcatons of the model. The H-statstc can be used to dentfy the three major market structures, namely, monopoly/perfect colluson, monopolstc competton and perfect competton/contestable market. Conclusons about the type of market structure are made based on the sze and sgn of the H-statstc. That s, both the sze and sgn are used to dfferentate between the dfferent market structures. The ntuton behnd the H-statstc rests solely on mcroeconomc theory, whch outlnes how revenues react to changes n nput prces for the dfferent market structures. Essentally, an ncrease n these costs wll reduce revenues for a frm enjoyng monopoly power, but ncrease that of a frm n a perfectly compettve market, proportonately. Therefore, t s expected that a perfectly compettve market wll have an H- statstc equal to one, whle the monopolst wll have a negatve H-statstc. The monopolstcally compettve market should have an H-statstc that s somewhere between zero and one. Each of these hypotheses s dscussed n greater detal n the followng secton. A summary of the testable hypotheses of the dfferent market structures s presented below. H-statstc Hypotheses H = 1 Perfect competton or monopoly n a contestable market 0 < H < 1 Monopolstc competton H 0 Monopoly or colluson Usng a smple, sngle product monopoly model wth the assumptons of constant prce elastcty and a constant returns to scale Cobb-Douglas technology, P-R further showed that not only s the sgn of the H-statstc mportant, but so too s ts sze. That s, a larger H-statstc means that the market s more compettve mplyng that the H-statstc s a contnuous measure of competton. 8
In applyng the P-R model, t s mportant to clearly defne the producton actvty of the banks snce they are not exactly comparable to other types of frms. The current lterature presents two alternatve approaches - the producton approach and the ntermedaton approach that can be taken n emprcal work. Although there s some amount of debate as to whch approach should be taken n emprcal work, ths paper wll follow the ntermedaton approach, whch classfes deposts and loans as nputs and outputs, respectvely. 21 4.1 Descrpton of the Model follows: The margnal cost (C ) and margnal revenue (R ) functons of the P-R model are as t ln C = φ 0 + φ1 ln y + ρ ln f + τ q (4) k = 1 n d = 1 k ln R = ω 0 + ω1 ln y + ψv (5) where, ln denotes the natural logarthm, y s the output of the bank, f s the factor nput d k p j= 1 j j prces, q and v are exogenous varables that shft the bank s cost and revenue functons respectvely. Settng margnal revenue equal to margnal cost the equlbrum proftmaxmzng condton yelds the followng equaton: t ln y = ( φ0 ω0 + ρ k ln f k + τ j q j - ψv d )/( φ1 ω 1 ) (6) k = 1 p j=1 Multplyng equaton (6), by the common prce level 22 yelds the reduced-form revenue equaton for bank. As such, to estmate the H-statstc for the Jamacan bankng sector the followng equaton was used: n d = 1 ln IR A = β + ρ + χ DL 1, t + λ LQA 4 + χ NLA, t 2 1 ln, t + ρ 2 ln, t + ρ3 ln, t IP + d t + δ + ε 1 + λ LA 1, t, t LP + λ LK 2, t KP, t + λ KA 3, t (7) 21 However, ths s not wthout some amount of debate. For further dscussons, see Hancock (1991), Huges and Mester (1993a, b) and Huges, Mester and Moon (2001). 22 The common prce level may be expressed as: lnp = σ + ϕln (y * ). See Bkker and Haaf (2001). 9
Where IR A s the rato of total nterest revenue (or nterest ncome) to total assets, IP (or the prce of deposts), s the rato of nterest expenses to total deposts, LP (or the prce of labour), s the rato of personnel expenses to total deposts plus loans plus nvestment and, KP (or the prce of captal), s the rato of fxed asset expenses to total fxed assets. Note that IP, LP and KP are all proxes used for the factor prces snce the actual prces are not avalable. The sum of the coeffcents on these varables, ( ρ 1+ ρ 2 + ρ 3 ), forms the H-statstc. Other control varables were also ncluded n equaton (7). These varables nclude (loans to captal), LA (loans to total assets), DL (deposts to loans), KA (captal to assets), (non performng loans to total assets) and LQA (lqud funds to assets) ratos. Equaton (7) was estmated usng a panel data set wth fxed effects to account for any heterogenety among the banks as well as to avod specfcaton problems. The ndvdual effects are represented by δ. A tme dummy, t, was also ncluded to account for the macroeconomc changes that occurred over the sample perod. LK LNA 5.0 Data A quarterly panel data set, coverng all of the thrteen (13) commercal banks that operated between the frst quarter of 1989 and the frst quarter of 2002, was constructed for use n estmaton. The data obtaned from BOJ ncluded the balance sheets and the proft and loss accounts of the commercal banks. The number of banks fell from eleven n 1989:1 to sx n 2002:1. Whle two banks had compettvely merged, others where forcbly merged or permanently closed by the Government. The data set treats merged banks as separate nsttutons before the merger and then subsequently as one bank. The specfed treatment of mergers suggests that the busness mx and compettve behavour of the banks does not change. 23 As stated n the ntroducton, the Jamacan bankng sector experenced sgnfcant changes over the sample perod. Table 2 shows that nterest ncome to assets ncreased, on average, durng the lberalsaton and post-lberalsaton perod, but declned over the remanng sample perod. The rapd expanson and contracton of the post lberalsaton and crss perods respectvely, suggest that these changes are n lne wth expectatons. Of the three factor costs, only captal prce declned durng the crss perod, whle all three fell durng the post-crss 23 See Hempell (2002) for further dscusson. 10
perod. The fact that there was no change n nterest and labour prces, between the post lberalsaton and crss perods, comes as a surprse snce these two perods were ntrnscally dfferent. 24 On the other hand, the bank specfc factors showed sgnfcant varaton n ther pattern of movement over the perod. The most notable of the group was loans to captal, whch fell dramatcally durng the post lberalsaton and post crss perods. Furthermore, the two lqudty ndcators gave conflctng reports of the ndustry s lqudty status over the sample range. Whle deposts to loans ndcate that lqudty ncreased steadly over the sample perod, lqud funds to assets suggest that lqudty fell durng the crss and post crss perods. 25 The latter result s n lne wth a pror expectatons. In addton, loans to assets fell n all perods subsequent to the lberalsaton perod as the hgh nterest rate reduced the banks loan portfolos. Also n lne wth expectatons, non-performng loans to assets ncreased sgnfcantly durng the crss and then fell to very low levels as the ndustry recovered. To capture the exstence of structural breaks n the bankng sector, the data were separated nto four (unequal) sub-perods representng the 1989 to 1991 lberalzaton, the 1992 to 1995 post-lberalzaton, the 1996 to 1999 crss, and the 2000 to 2002 post-crss sub-perods. The factor prces were then nteracted wth dummes representng each of these sub-perods, excludng the lberalzaton perod, and then estmated wthn one regresson. Any statstcally sgnfcant nteracton term would ndcate a change n compettve behavour (and thus, the H- statstc). The drecton of the change s determned by the sgn of the nteracton term. An F-test s used to determne the sgnfcance of any reported changes n the H-statstc. 5.0 Emprcal Results The thrd column n Table 3 presents the results from the estmaton of equaton (7). Usng nterest ncome as the dependent varable allows for a complete analyss of market power n the bankng sector. The nteracton terms, for the post lberalsaton, crss and post crss subperods, should gve an ndcaton of whether or not competton changed over the perod and the drecton of any such change. These emprcal results suggest that the bankng sector may be characterzed by monopolstc competton (albet declnng competton) over the sample perod, snce the 24 Recall that the ndustry expanded rapdly durng the post lberalsaton perod before collapsng n the md-90s. 25 Lqud funds to assets s a more comprehensve measure of lqudty. 11
estmated H-statstc s always below one and above zero. Ths s verfed by the fact that the hypotheses of perfect colluson and perfect competton/contestable market are both rejected at the one percent level of sgnfcance. Ths means that the H-statstc for the overall sample perod (0.63) s sgnfcantly dfferent from zero and one, thus fulfllng the requrement to be characterzed as a monopolstc market. Interest prce s the factor that contrbuted the most to the H-statstc across the subperods, reportng a sgnfcant and postve coeffcent value of 0.550 for the overall sample perod. The coeffcent on the captal prce also reported a sgnfcant postve value. However, ths was consstently lower than the coeffcent on the nterest prce and was sgnfcant for the overall sample perod only. Ths suggests that ths prce remaned proportonal to output throughout ths perod. The coeffcent on labour prce, on the other hand, reported an nsgnfcant value for the overall sample perod, ndcatng that t was an unmportant factor prce. Of the bank-specfc factors (BSF), loans to assets and deposts to loans were the only sgnfcant ratos. The postve sgn on the loans to assets coeffcent s n lne wth expectatons snce the accumulaton of loans means that banks would be accumulatng more nterest revenue. The coeffcent on the depost to loans rato, measurng busness mx, was also postve. Ths ndcated that banks wth hgher levels of lqud funds, n the form of deposts, to fund ther loan portfolo had greater levels of nterest ncome. As outlned earler n the methodology, nteracton terms were ntroduced for the subperods 1992 to 1995, 1996 to 1999 and 2000 to 2002. Estmatng equaton (7) wth all the nteracton terms allowed for the testng of changes n the H-statstc over the sample perod. Ths was acheved by usng the sgnfcant nteracton terms to adjust the H-statstc for the respectve sub-perods. The sgnfcance of ths test for structural change was computed by usng the Wald Coeffcent Test (F-test). Importantly, accordng to a pror expectatons, competton n the bankng sector should ncrease wth the onset of fnancal lberalzaton. That s, pror to the removal of celngs on nterest rates, banks are generally unable to take full advantage of the rsk-return trade-off n ther portfolos, makng t unproftable to fund excessvely rsky ventures. Ths creates sgnfcant economc rents from relatonshp bankng. However, lberalzaton should ncrease the pool of welfare enhancng projects ncreasng the number of hgher proft opportuntes 12
assocated wth hgher levels rsk. Ths wll reduce banks franchse values and lead to entry and competton n the fnancal system. Table 3 shows that durng the post-lberalsaton perod, there was a sgnfcant reducton n the H-statstc for nterest ncome mplyng that the ndustry became less compettve durng ths perod. Ths contrasts wth the expectaton that fnancal lberalzaton would sgnfcantly ncrease competton n the bankng sector. The crss and post crss perods also saw further reductons n the H-statstc. However, ths result s consstent wth expectatons gven the consoldaton n the sector. The low and declnng H-statstc may be explaned by the fact that the two domnant banks average share of nterest ncome ncreased from 61 percent before the crss to 72 percent after. 26 Although the results mply that competton deterorated followng the crss sub-perod, the hypothess of perfect colluson was rejected at each stage, suggestng that the ndustry remaned monopolstcally compettve over the perod. An mportant pont that must be establshed here s that the results of the P-R model are more robust than that for the Herfndahl-Hrschman Index. The HHI, whch only provdes a measure of concentraton, may be explaned by three alternatve theores to make the lnk between concentraton and market power. For example, accordng to the HHI dscussed earler, concentraton fell slghtly durng the pre crss sub-perod, rose sgnfcantly durng the crss sub-perod and then remaned constant durng the post crss sub-perod. Makng the lnk between these observed changes n concentraton and market power would lead to three dfferent dynamc paths for compettve behavour. 27 It s ths subjectve nature of the HHI that has led to t beng an unrelable measure of market power. The P-R model, however, measures market power drectly and thus leaves lttle room for subjectvty. As such, the result from the P-R model s generally more robust and relable, than the HHI, and thus gves a better measure of market power over a specfed perod. The robustness of the P-R model s further verfed by the fact that varatons n model specfcaton had an nsgnfcant mpact on the H-statstc. Table 3 also dsplays the results from the estmaton of equaton (7) wth total ncome as the dependent varable. The purpose of ths analyss s to examne the effect that non-nterest ncome had on the H-statstc gven that the share of non-nterest ncome n total ncome averaged, more or less, between 10 and 20 percent 28 over the sample perod. Further more, the 26 See Fgure 4. 27 Recall that there are three dfferent theores, the Structure Conduct Performance, Effcency and Contestablty paradgms. 28 Ths mples that nterest ncome averaged above 80 percent of total ncome for the sad perod. See Fgures 5 and 6. 13
ntermedaton approach used n the applcaton of the P-R model does not ncorporates the actvtes generatng non-nterest ncome. The results n Table 3 show that the total ncome varant of the model yelded a lower adjusted R-squared (0.59) than that for nterest ncome (0.69) suggestng, as expected, that nterest ncome gave the better ft. In addton, the H-statstc reported for total ncome (0.46) was sgnfcantly lower than that for nterest ncome (0.63). Ths s due prmarly to the fact that non-nterest ncome actvtes do not depend, sgnfcantly, on nterest prce. Therefore, estmatng equaton (7) wth total ncome, ntroduced a down ward bas n the estmated H-statstc. Ths suggests that the sector s less compettve wth the ncluson of non-nterest ncome. Fgure 5 ndcates that the dstrbuton of market shares for non-nterest ncome was mostly concentrated n only two nsttutons. Ths provdes the ntuton for the downward bas (towards a lower level compettveness) n the H-statstc. Notwthstandng, both dependent varables led to the same concluson about the market structure of the commercal bankng sector. That s, they both suggest that the sector s monopolstcally compettve. 7.0 Concluson The macroeconomc polces mplemented durng the early 1990s to adjust the structure of the Jamacan economy brought about sgnfcant changes n the bankng ndustry. The objectve of ths paper was to examne the effect of such changes on the market structure of the bankng ndustry. The Herfndahl Hrschman Index, along wth the accompanyng structural theores, was used to analyse changes n the level of concentraton and competton n the ndustry over the perod. Results from ths analyss revealed that there was a slght ncrease n competton followng fnancal lberalzaton. However, the ndustry became more concentrated after the fnancal crss n the md-1990s, whch mght suggest that there was a declne n competton among the banks. However, the ambguous nature of the HHI necesstated the use of the more robust Panzar and Rosse methodology to measure the market power of the ndustry. Based on the results from ths alternatve methodology, competton actually fell slghtly mmedately followng the lberalzaton perod. Furthermore, the hypotheses of monopoly/perfect colluson and perfect competton/contestable market were both rejected n favour of monopolstc competton for the entre sample perod. Interacton terms used to track changes n market power over tme also ndcated that there was a steady declne n competton throughout the 14
specfed sample perod. The contnual reducton n competton over the sample perod casts doubt on the welfare benefts to consumers wth regard to ncreased competton from fnancal lberalzaton n the Jamacan case. It s clear that the events of the md-1990s led to sgnfcant changes n the concentraton of the commercal bankng sector. Although the specfc relatonshp between concentraton and market power remans unclear when usng the HHI, t stll provdes a farly accurate measure of ndustry concentraton. The P-R model, however, s preferred n testng for possble changes n market power when adjustments n concentraton are sgnalled by the HHI. The results of the P- R model ndcated that competton deterorated over the sample perod. Ths suggests that the ncreased concentraton durng the perod dd, n fact, affect competton negatvely. 15
References Baumol, W., J. Panzar, and R. Wllg, 1982, Contestable Markets and the Theory of Industry Structure (New York: Harcourt Brace Jovanovch). Berger, A. and T. Hannan, 1989, The Prce Concentraton Relatonshp n Bankng. The Revew of Economcs and Statstcs, Vol. 71, pp 291 299. Bkker, J. and K. Haaf, 2001, Competton, Concentraton and Ther Relatonshp: An Emprcal Analyss of the Bankng Industry. Workng Paper De Nederlandsche Bank. Burdsso, T. and L. D Amato, 1999, Prudental Regulatons, Restructurng and Competton: The Case of the Argentne Bankng Industry. Research Department, Banco Central de la Republca Argentna, Workng Paper No.10. Chamberln, E., 1962, The Theory of Monopolstc Competton, Harvard Unversty Press, Cambrdge Mass, 8 th edton. Cetorell, N., 1999, Compettve analyss n the Bankng: Apprasal of the Methodologes. Economc Perspectves, Federal Reserve Bank of Chcago. Gelos, G., 2002, Consoldaton and Market Structure n Emergng Markets Bankng Systems, Workng Paper, Internatonal Monetary Fund. Green, P., 1999, Preservng the Integrty of the Jamacan System: The Challenges, Mmeo, Research Servces Department, Bank of Jamaca. Hancock, D., 1991, A Theory of Producton of the Fnancal Frm, Norwell, Mass.: Kluwer Academc Publshers. Hempell, H., 2002, Testng for Competton Among German Banks, Dscusson Paper 04/02, Economc Research Centre of the Deutsche Bundesbank. Huges, J.P., and L. J. Mester, 1993a, A Qualty and Rsk-Adjusted Cost Functon for Banks: Evdence on the Too-Bg-to-Fal Doctrne, Journal of Productvty Analyss, Vol. 4, No. 3, pp. 293-315., 1993b, Accountng for the Demand for Fnancal Captal and Rsk-Takng n Bank Cost Functons, Workng Paper No. 93-7, Federal Reserve Bank of Phladelpha, Economc Research Dvson. Huges, J., Mester, L. and Moon, 2001, Are Scale Economes n Bankng Elusve or Illusve? Evdence Obtaned by Incorporatng Captal Structure and Rsk-Takng nto Models of Bank Producton, Journal of Bankng and Fnance, Vol. 25, 2169-2208. 16
Jackson, W., 1997, The Prce-Concentraton Relatonshp n Bankng: A Comment, Revew of Economcs and Statstcs, Vol. 74, 373-376. Nakane, M., 2001, A Test of Competton n Brazlan Bankng, Workng Paper No. 12, Research Department, Banco Central Do Brasl. Nathan, A. and E. Neave, 1989, Competton and Contestablty n Canada s Fnancal System: Emprcal Results, The Canadan Journal of Economcs, Vol. 22, pp. 576-594. Panton, N., 1996, The Commercal Bankng Industry In Jamaca: Some Issues of Effcency, Fnancal Sector Unt, Research Servces Department, Bank of Jamaca. Panzar, J. and J. Rosse, 1987, Testng for Monopoly Equlbrum, Journal of Industral Economcs, Vol.35, pp. 443-456. Shaffer, S., 1993, A Test of Competton n Canadan Bankng, Journal of Money, Credt, and Bankng, Vol. 25, pp. 49-61. Stennet, R., P. Batchelor and C. Foga, 1999, Stablsaton and the Jamacan Commercal Bankng Sector (1991-1997), Socal and Economc Studes, pp. 345-377. Vesala, 1995, Testng Competton n Bankng: Behavoural Evdence from Fnland, Bank of Fnland Studes, Workng Paper No. E: 1. 17
Table 1. Dynamcs of the Commercal Bankng Sector (1989-2002) Year No. of Banks at end-year Total Assets $JA( 000) Annual Growth Rate of Assets (%) Entrants Exts Change of ownershp/ merger Adjustments n Lqud Assets Requrements for Commercal Banks 1989 11 $15,114,226.00 - - - - - 1990 11 $17,088,608.00 13.1 - - - 1991 10 $27,394,782.00 60.3 - BCCI - 20.5 to 25.0 25.0 to 27.5 27.5 to 32.5 32.5 to 33.5 33.5 to 20.0 1992 11 $46,624,739.00 70.2 IVB - - 20.0-50.0 1993 11 $61,716,860.00 32.4 - - - - 1994 11 $95,094,265.00 54.1 - - - - 1995 11 $119,475,970.00 25.6 - - - 50.0 to 47.0 1996 9 $128,089,301.00 7.2 - CNB, MSB NCB acqured ownershp of MSB - 1997 9 $142,433,094.00 11.2 - - - - 1998 9 $165,039,652.00 15.9 - - - 47.0 to 45.0 45.0 to 43.0 1999 6 $190,895,027.00 15.7 UB IVB, ECB, WSL, CBL IVB, ECB, WSL, CBL merged to form UB 43.0 to 41.0 41.0 to 39.0 39.0 to 35.0 35.0 to 34.0 2000 6 $216,479,457.00 13.4 RBTT UB UB sold to RBTT. 2001 6 $234,628,213.00 8.4 - - - 34.0 to 33.0 33.0 to 32.0 32.0 to 31.0 31.0 to 30.0 30.0 to 29.0 29.0 to 28.0 2002 6 $248,581,188.00 - - - NCB sold to AIC - 18
Table 2. Descrptve Statstcs 29 Sub-Perods 1989-1991 1992-1995 1996-1999 2000-2002 Total Income 0.06 0.06 0.05 0.03 /Assets 0.03 0.02 0.02 0.03 Interest Income / 0.05 0.05 0.04 0.03 Assets 0.03 0.02 0.02 0.03 Non. Interest 0.01 0.01 0.01 0.00 Income/Assets 0.01 0.01 0.00 0.01 Interest 0.06 0.42 0.05 0.16 cost/assets 0.06 4.97 0.05 2.85 Personnel costs/ 0.01 0.01 0.01 0.01 (deposts+loans+ 0.00 0.04 0.00 0.02 nvestments) Captal costs/ 0.12 0.17 0.11 0.07 Fxed Assets 0.16 0.17 0.07 0.08 Loans/ 0.44 0.32 0.34 0.20 Assets 0.13 0.08 0.16 0.19 Captal/ 0.07 0.09 0.01 0.03 Assets 0.04 0.10 0.34 0.18 Non. Performng 0.01 0.02 0.03 0.01 Loans/Assets 0.03 0.03 0.11 0.06 Loans/ 27.42 5.00 3.69 8.08 Captal 189.79 3.52 7.44 94.00 Lqud 0.40 0.38 0.27 0.23 Funds/Assets 0.13 0.09 0.14 0.20 Deposts/ 1.50 2.16 2.46 1.63 Loans 0.47 0.47 0.47 0.47 29 Means wth standard devatons n talcs. 19
Table 3. Emprcal Results Interest Income/ Total Income/ Factor Prces Assets Assets 1989-2002 Interest Prce 0.55** 0.367** Other Varables Post- Crss Perod Crss Perod Post- Lber. Perod Entre Sample Perod (8.461) (4.829) Labour Prce -0.040 0.093 (-0.792) (1.727) Captal Prce 0.076* 0.0956* (2.747) (2.609) H statstc 0.63 0.46 P(F test)^ 0.00** 0.00** P(F test)^^ 0.00** 0.00** 1992-1995 Interest Prce -0.233** -0.156* (-4.808) (-2.473) Labour Prce 0.123** 0.09* (3.808) (2.627) Captal Prce -0.037-0.029 (-1.116) (-0.600) H statstc 0.52 0.40 P(F test)~ 0.00** 0.00** 1996-1999 Interest Prce -0.365** -0.172 (-3.384) (-1.559) Labour Prce 0.205* 0.132 (2.634) (1.813) Captal Prce 0.015-0.050 (0.322) (-0.925) H statstc 0.47 0.46 P(F test)~ 0.00** 0.05 2000-2002 Interest Prce -0.458** -0.217* (-5.066) (-2.198) Labour Prce 0.274** 0.159* (4.443) (2.616) Captal Prce 0.049-0.015 (1.008) (-0.266) H statstc 0.44 0.40 P(F test)~ 0.00** 0.08 Depost/ 0.097** 0.088** Loans (5.322) (4.310) Loans/ 1.011** 0.946** Assets (4.132) (3.831) Tme -0.004-0.003 (-1.755) (-1.250) Non-performng 0.266 0.306 Loans/Assets (0.988) (1.283) Loans/ 0.000-0.006* Captal*100 (-0.12) (-2.514) Captal/ 0.112 0.163 Assets (0.791) (1.323) Lqud Funds/ 0.104 0.374* Assets (0.654) (2.346) (F-value)fe 4.57** 2.37* Adj. R 0.69 0.59 M ax. No. of Banks 13 13 Max. No. of Obs. 497 497 Note: 1. "^" and "^^" ndcate P values for the hypotheses H=1 and H=0 respectvely. 2. "~" gves the P values for the test for changes n the H statstc over tme. 3. T- values for the dfferent varables, calculated from robust standard errors, are gven n parentheses. 4. "*" Sgnfcance at 5% level. 5. "**" Sgnfcant at the 1% level. 20
Fgure 1. Herfndahl-Hrschman Index (Deposts) 4000 3500 3000 2500 2000 1500 1000 500 0 Mar-89 Sep-89 Mar-90 Sep-90 Mar-91 Sep-91 Mar-92 Sep-92 Mar-93 Sep-93 Mar-94 Sep-94 Mar-95 Sep-95 Mar-96 Sep-96 Mar-97 Sep-97 Mar-98 Sep-98 Mar-99 Sep-99 Mar-00 Sep-00 Mar-01 Sep-01 Mar-02 Tw o Domnant Banks' HHI(d) Market HHI(d) Fgure 2. Herfndahl-Hrschman Index (Assets) 3500 3000 2500 2000 1500 1000 500 0 Mar-89 Sep-89 Mar-90 Sep-90 Mar-91 Sep-91 Mar-92 Sep-92 Mar-93 Sep-93 Mar-94 Sep-94 Mar-95 Sep-95 Mar-96 Sep-96 Mar-97 Sep-97 Mar-98 Sep-98 Mar-99 Sep-99 Mar-00 Sep-00 Mar-01 Sep-01 Mar-02 Market HHI(a) Tw o Domnant Banks' HHI(a) 21
Fgure 3. Herfndahl-Hrschman Index (Deposts and Assets) 4000 3500 3000 2500 2000 1500 1000 500 0 Dec-88 Jun-89 Dec-89 Jun-90 Dec-90 Jun-91 Dec-91 Jun-92 Dec-92 Jun-93 Dec-93 Jun-94 Dec-94 Jun-95 Dec-95 HHId Jun-96 Dec-96 Jun-97 HHI(a) Dec-97 Jun-98 Dec-98 Jun-99 Dec-99 Jun-00 Dec-00 Jun-01 Dec-01 Fgure 4. Market Share of Interest Income of the Two Domnant Banks 90.00% 80.00% 70.00% 60.00% 50.00% 40.00% 30.00% 20.00% 10.00% 0.00% Tw o domnant banks' share of Interest Income 22
Fgure 5. Interest and Non-Interest Income as a Percentage of Total Income 100.00% 90.00% 80.00% 70.00% 60.00% 50.00% 40.00% 30.00% 20.00% 10.00% 0.00% Mar-89 Sep-89 Mar-90 Sep-90 Mar-91 Sep-91 Mar-92 Sep-92 Mar-93 Sep-93 Mar-94 Sep-94 Mar-95 Sep-95 Mar-96 Sep-96 Mar-97 Sep-97 Mar-98 Sep-98 Mar-99 Sep-99 Mar-00 Sep-00 Mar-01 Sep-01 Mar-02 Non-Interest Income as a Percentage of Total Income Interest Income as a Percentage of Total Income Fgure 6. Market Share of Non-nterest Income of the Two Domnant Banks 100.00% 90.00% 80.00% 70.00% 60.00% 50.00% 40.00% 30.00% 20.00% 10.00% 0.00% Mar-89 Sep-89 Mar-90 Sep-90 Mar-91 Sep-91 Mar-92 Sep-92 Mar-93 Sep-93 Two Domnant Banks' share of Non-Interest Income Mar-94 Sep-94 Mar-95 Sep-95 Mar-96 Sep-96 Mar-97 Sep-97 Mar-98 Sep-98 Mar-99 Sep-99 Mar-00 Sep-00 Mar-01 Sep-01 Mar-02 23