How best to improve competition in the banking market - Essay Example

? How best to improve competition in the banking market By Business of Introduction It is within general knowledge that banks are unique in that they are susceptible to instability. As indicated by numerous occurrences of crises, banks are fragile and prone to take excessive risks (BETTAZZONI, 2004). The banks’ roles as intermediaries between firms and borrowers and the maturity transformation they operate in their asset-liability management make banks play a fundamental role as providers of liquidity to depositors; however, they render them to runs and methodical crises. This essay seeks to examine the significance of a quiet life hypothesis (QLH) and efficient structure hypothesis (ESH) in improving competition in the banking sector. As a point of departure, a quiet life hypothesis (QLH) refers to a situation where firms with superior market power take advantage of the benefits from non-competitive pricing in a calmer milieu, in which less endeavor is put into rigors of minimizing cost. In essence, QLH means the relaxed manner in which banks the gains of market power in terms of predetermined revenues or cost savings (WISE, BLINDER & GORDON, 2001). It is imperative to note that, QLH is not a paradigm in itself. The primary role of a quiet life hypothesis is to help clarify why prices tend to be much more robustly associated to concentration than profits. Efficient structure hypothesis ESH This is a hypothesis that postulates that the interlinking between the market structure and performance of any firm is defined by the efficiency of the firm. For instance, the firms that have superior management or production technologies possess low cost and this implies high profits. In most cases, application of the efficient structure hypothesis is projected in two primary ways depending on the nature of efficiency considered. When considering the X-efficiency form, the more efficient organizations have relatively lower costs, which results to higher profits and a larger share market. According to WISE, BLINDER & GORDON, (2001), this is true because of presence of superior ability in diminishing production costs. On the other hand, Scale Efficiency form serves the same purpose as the X-efficiency, since it works towards achieving production to the minimum average-cost point. Relationship between quiet Life Hypothesis and efficiency structure If quiet life hypothesis holds, then it implies that, the positive profit structure association is partially offset by cost increase from poorer cost efficiency, which explains why the profit-structure association is weak in numerous banks. A unified approach based on the both quiet life hypothesis, structure hypothesis can be used to define the degree to which competition, and stability in the banking sector is influenced (WISE, BLINDER & GORDON, 2001). Structure Conduct Performance The SCP studies of banking universally can be subdivided into two primary groups according to the measure of performance (JOHNSON, 2003). The groups include the use of measure of pieces of some banking products and service in order to capture the firm’s performance. The second involves the application of profitability measure such as return on assets or equity. Nonetheless, using the piece of a single product may be misleading sue to the multi-product nature of a bank’s output. On the other hand, profit measure may be more informative, however may exhibit difficulty in comprehending and interpreting due to the complexity of the accounting procedures. Relationship between QLH, ESH and SCP The relationship between market structure and performance treated within the framework of structure-Conduct –Performance (SCP) explains well, the competitive status of a banking system. The SCP closes relates with that efficiency Hypothesis (JOHNSON, 2003). When Efficiency Hypothesis is applied in a banking sector, the hypothesis defines that a bank, which operates more efficiently than its competitors achieve higher gains that results from low operational costs. On equal measure, the same bank holds a significant share of the market. On the other hand, the differences at the level of efficiency create an unequal distribution and performance and the positive association between the two appears to be superficial. Efficiency as a significant factor of competitiveness, receives multidimensional interests warranted by the coexistence of well-defined abilities and skills making up an intertwined and interconnected set, which we cannot diminish nor overlook the value of one over the other (WEISS, AUDRETSCH & YAMAWAKI, 2001). Efficient structure vs. Market power The efficiency hypothesis, considers market share as a proxy for efficiency. Te efficiency hypothesis prevails when a significant positive interrelationship between market share and profitability and bank cost efficiency is indicated. Quite life hypothesis is rejected in this case (BROWN, 2008). On a similar note, the market power can be used to elevate profits and prices in the short run. The market power will demonstrate in a Lerner index (BETTAZZONI, 2004). A market power can be used to select the best clients that achieve relatively lower portfolio risk and lowering the possibility of bankruptcy. This market power needs to be closely correlated with increased franchise value. It should be noted that, the banks do not supply a homogeneous product and choose a price, this leads to variance in the quality of the products. However, the probability of the risk changing provides extra proportions to the usual output –price choice (WISE, BLINDER & GORDON, 2001). In essence, the implication of the ES is in sharp contrasts with that of the structure-conduct-performance hypothesis (BETTAZZONI, 2004). The SCP predicts that a concentrated market engenders a low extent of competition and this leads to market efficiency characterized by monopolistic pricing and excess gains. In addition, the SCP hypothesis predicts a positive association between concentration and profits, however through a different instrument. It does not call for anti-concentration measures (BROWN, 2008). Taking into account the determination of the firms’ efficiency by simultaneous estimation of an equation with the efficiency measure as a dependent variable, creation of a direct merit of successive estimation of efficiency is evidenced. This will increase efficiency of estimation (BETTAZZONI, 2004). The quiet-life hypothesis suggests that a concentrated market firms do not minimize costs because of insufficient managerial effort, absence of profit maximizing conduct, wasteful expenditure to obtain and sustain monopoly power and survival of inefficient managers. Testing the hypothesis the efficiency regression is examined to check whether firms in an immensely concentrated market are more efficient (BETTAZZONI, 2004). Although, the ES hypothesis and quiet-life hypothesis have conflicting implications, their impacts might co-exist in a short run. Application of this test in banks in Japan, It is found that, more efficient banks tend to become larger, however, we also find that banks in a more concentrated market are more efficient and this is consistent with the quite-life hypothesis. These findings have implications that efficiency allows firms to survive competition and enhance growth, which results to eroding of market concentration leading to a firm efficiency (NEEDHAM, 2008). List of references BETTAZZONI, M. (2004). Illness intrusiveness and quality of life in schizophrenia. Thesis (Ph. D.)--University of Toronto, 2004. BROWN, J. R. (2008). Why don't people insure late life consumption a framing explanation of the under-annuitization puzzle. Cambridge, Mass, National Bureau of Economic Research. http://papers.nber.org/papers/w13748. WISE, D. E., BLINDER, A. S., & GORDON, R. H. (2001). Social Security, Bequests, and the Life Cycle Theory of Saving Cross-Sectional Tests. Cambridge, Mass, National Bureau of Economic Research. http://papers.nber.org/papers/w0619. WEISS, L. W., AUDRETSCH, D. B., & YAMAWAKI, H. (2001). Structure, conduct, and performance. New York, New York University Press. JOHNSON, P. S. (2003). European industries: structure, conduct, and performance. Aldershot, Hants, England, Elgar. NEEDHAM, D. (2008). The economics of industrial structure, conduct, and performance. New York, St. Martin's Press. Read More