Concentration Ratio of Banking Industry in European Union - Case Study Example

Table of Content I. Map of UK and the European Union …………….……………….. 3 II. Introduction ……………………………………………………….. 4 Business Environment in EU III. Effects of the EU Agreement within the Domestic Market …………………………………………….… 4 a. Purpose of EU Agreement in Domestic Market …………. 4 b. Effects of EU Agreement in Employment ……………….. 6 IV. Effects of the EU Agreement within the International Market ……. 9 V. Effects of Centralized Currency ………………………………….… 11 Banking Industry in EU VI. Effects of the Economic Changes in the Banking Industry ……….. 12 VII. EU Banking Regulatory Intervention ……………………………… 12 VIII. Competition in the Banking Industry ……………………………… 13 IX. Concentration Ratio in EU Banks …………………………………. 13 X. Conclusion …………………………………………………………. 14 References ………………………………………………………………….. 15 - 16 Map of UK and the European Union Introduction Back in 1951, six European states came into an economic agreement forming the European Union (EU). Today, there are 27 countries across European continent as members of the EU.1 These countries include: Austria, Belgium, Bulgaria, Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, Netherlands, Poland, Portugal, Romania, Slovakia, Slovenia, Spain, Sweden, and UK. The use of ‘Euro’ (€) was launched in the world money markets back in January 1, 1999. Since then, Euro has become the unit of exchange for the EU states except for the United Kingdom, Sweden, and Denmark. The initiative of the European Commission way back in 1969 is to coordinate the economic policies as well as to set a monetary integration among the European Union. In 2007, the goal European Commission has proven to be very successful. Having implemented the ‘Euro’ (€) currency back in 1999 is part of the strategy used by the European Union in achieving their purpose of making the inter-regional and inter-state trading much easier. The constantly growing economic activity within the European Union has resulted to a tight competition among the members of the EU banking and financial sector. In order to cope with the intensive competition within the industry, most of the small banks have decided to enter into a merger. The merger of the small and medium scale banks would enable them to maximize its resources through the use of economies of scale. Effects of the EU Agreement within the Domestic Market Purpose of EU Agreement in Domestic Market The purpose of the European Union agreement is to allow inter-state trading of goods and services in order to attain a better and more competent economy. The ‘trade and investment relationship’ between the current EU members with a more profitable investment locations in Central and Eastern Europe is very promising. In fact, the ‘concept’ of inter-state trading and investments is being used by the EU commissioners to encourage more countries to become a member of the European Union.2 It has been evident that the inter-regional policy of the European Union resulted to the power of every EU members to do trading within a wider domestic market. It also provides more employment opportunity for the local people before globalization in 2001. Given the huge domestic market of the European Union, the members of EU is able to gain more strength that attracts many of the World Trade Organization (WTO) members to deal with the European Union.3 (See Table I below and Chart I on page 6) Table I - GDP of European Union (EU) -As of Year 1998 to 2004 -   1998 1999 2000 2001 2002 2003 2004 Austria 41.0 41.8 44.7 46.6 46.3 46.6 48.5 Belgium 73.3 73.5 84.0 84.0 81.5 79.6 82.3 Czech Republic 55.6 57.1 66.0 67.8 62.5 63.3 71.5 Denmark 37.2 38.2 43.6 44.0 44.6 42.4 43.2 Finland 33.9 33.3 38.2 35.7 34.3 33.8 35.1 France 24.9 25.1 28.1 27.5 26.3 25.2 25.8 Germany 28.0 29.0 33.2 33.8 33.4 33.7 35.6 Greece 24.0 26.7 30.8 27.9 25.0 24.3 25.2 Hungary 62.1 65.1 75.8 73.5 65.3 64.9 67.3 Ireland 80.8 82.0 91.8 92.1 84.8 75.7 75.5 Italy 24.6 24.5 27.8 27.7 26.5 25.5 26.2 Luxembourg 119.9 127.9 141.4 144.4 134.3 128.1 135.4 Netherlands 58.2 58.1 64.9 62.6 60.2 59.0 62.7 Poland 28.9 27.6 31.1 29.5 31.3 35.7 40.0 Portugal 35.3 34.9 37.2 35.7 33.9 33.3 34.5 Slovak Republic 65.1 63.6 72.0 77.5 75.3 78.4 78.1 Spain 26.8 27.6 30.6 29.8 28.3 27.5 27.8 Sweden 39.4 39.6 43.2 42.7 40.8 40.4 42.3 United Kingdom 27.3 27.3 29.0 28.8 27.7 26.9 26.7 Total 886.3 902.9 1,013.4 1,011.3 962.5 944.3 983.8 Source: OECD, 2006 Notice that between years 1998 to 2000, the GDP of European Union has been constantly increasing. It means that the production output of the European Union was steadily growing. Normally, when the GDP is increasing, the unemployment is decreasing. Starting in 2001 when globalization became active, the GDP of European Union has gradually declined. At this point, the unemployment rate is likely to be increasing. It was only in 2004 when the total GDP of the EU has increased by 4%. (See Table II and Chart II on page 7) Effects of EU Agreement in Employment Years before the globalization became very active; the unemployment rate of the European Union has been sloping downwards. It means that the economic activity of EU prior to globalization has been doing well. Over the years, the sound economic performance of ‘EU’ is distracted by the increase of international trading. Particularly when the open trading of products and services with the Asian countries became easily accessible back in 2001, many of the businessmen from developed countries started to enter into subcontract with the countries like: China, the Philippines, Indonesia, Malaysia, Korea, etc. Their goal is to be able to find alternative sources of products and services at a lower cost. This fact that the competition in both domestic and global markets has become very competitive is evident with the huge increase in unemployment statistics of the European Union between the years 2001 to 2004.4 (See Table II and Graph I1on page 7; Table III and Graph III on page 8) Table II - Unemployment Statistics of European Union (EU) - As of Year 2000 to 2005 -   2005 2004 2003 2002 2001 2000 Austria 208 195 183 193 153 180 Belgium 370 329 336 300 265 290 Czech Republic 410 425 398 376 409 441 Denmark 138 150 152 121 117 127 Finland 207 219 223 225 217 241 France 2,620 2,620 2,444 2,196 2,148 2,444 Germany 4,568 4,201 3,843 3,303 3,028 3,051 Greece 467 493 442 463 445 491 Hungary 298 253 245 239 234 264 Ireland 85 85 83 77 66 - Italy 1,771 1,863 2,129 2,190 2,252 2,524 Luxembourg 9 10 7 5 4 4 Netherlands 402 388 295 207 - - Poland 3,046 3,230 3,328 3,431 3,169 2,792 Portugal 397 346 333 242 203 195 Slovak Republic 428 481 460 488 509 480 Spain 1,700 2,048 1,983 1,941 1,716 2,410 Sweden - 295 256 234 227 260 United Kingdom 1,326 1,340 1,391 1,451 1,387 1,631 Total 18,242 18,776 18,348 17,489 16,396 17,645 Source: OECD, 2006 Table III - Imported Goods & Services in European Union   1995 2004 Austria 36.3 51.2 Belgium 72.7 88.4 Czech Republic 45.2 85.9 Denmark 34.2 47.0 Finland 28.9 37.8 France 21.3 28.8 Germany 24.6 37.7 Greece 22.6 29.3 Hungary 41.3 89.8 Ireland 65.7 98.0 Italy 23.0 27.3 Luxembourg 117.2 166.8 Netherlands 56.0 74.9 New Zealand 31.7 39.6 Poland 20.6 35.0 Portugal 32.1 41.1 Slovak Republic 53.8 90.7 Spain 22.0 33.5 Sweden 32.4 43.9 United Kingdom 23.0 30.8 Total 804.6 1,177.5 Source: OECD, 2006 Effects of the EU Agreement within the International Market The increasing size of the European Union as a single market that is being sustained by a collective European trade policy as well as its more than forty-years of experience in negotiating with international trade agreements has enable the EU to become a close competitor of the United States in terms of the international trade negotiation.5 Based on the 2006 OECD report on the Foreign Direct Investment that flows in and out of OECD countries, the total inward Direct Foreign Investment has reached a total of US$430.5 billion while the outward Foreign Direct Investment has totalled to US$ 557.1 billion in 2005.6 (See Table IV below and Chart IV on page 10; Table V on page 10 and Chart V on page 11) Table IV - Inward Foreign Direct Investment in bn. US$ -As of April 2006 -   2003 2004 2005 Austria 7.1 4.0 -36.8 Belgium 33.4 42.1 23.7 Czech Republic 2.1 5.0 11 Denmark 2.9 9.3 5 Finland 3.3 3.5 4.6 France 42.5 24.3 49.8 Germany 26.9 15.1 32.6 Greece 0.7 1.4 0.6 Hungary 2.2 4.7 6.7 Ireland 22.8 11.2 22.8 Italy 16.4 16.8 15.7 Luxembourg 90.2 77.3 29.3 Netherlands 21.7 0.4 40.8 Poland 4.1 12.4 8.7 Portugal 6.6 1.6 3.1 Slovak Republic 0.6 1.1 1.9 Spain 25.9 16.7 18.8 Sweden 5.0 12.6 13.7 United Kingdom 27.4 77.7 164.5 Total 341.8 312.8 430.5 Source: OECD BOP & Int'l Investment Statistics, 2006 Table V - Outward Foreign Direct Investment in bn. US$ -As of April 2006 -   2003 2004 2005 Austria 6.8 7.3 - Belgium 36.9 33.5 22.9 Czech Republic 0.2 1.0 0.9 Denmark 1.3 -10.2 7.9 Finland -2.6 -1.1 2.7 France 53.2 47.8 99.2 Germany 3.6 1.9 45.6 Greece 0.0 0.6 1.4 Hungary 1.6 1.1 1.3 Ireland 3.5 15.8 12.9 Italy 9.1 19.3 41.3 Luxembourg 101.1 81.7 37.6 Netherlands 37.8 17.3 123.1 Poland 0.2 0.8 1.1 Portugal 7.3 7.1 7,1 Slovak Republic 0.0 -0.2 0.1 Spain 23.4 49.5 32 Sweden 21.3 21.0 26 United Kingdom 66.7 96.3 101.1 Total 370.4 402.0 557.1 Source: OECD BOP & Int'l Investment Statistics, 2006 Effects of a Centralized Currency Since a ‘single currency’ is imposed on the Eurozone countries; the members of the European Union can use only one monetary policy for all. It means that only ‘one’ interest rate will be implemented by the European Central Bank (ECB) to all members of EU. In case of an economic problem, the national government is therefore deprived of using the monetary policy (monetarism) to solve any economic issues. This leaves them the option to control over the fiscal policy instead. Aside from the political issue attached with having a single currency, this strategy can be beneficial for the participating countries in terms of inter-trading opportunities, currency stability and having a transparency in the costs of goods and services.7 Effects of the Economic Changes in the Banking Industry Over the years, the economic trend of the European Union has changed a lot. The implementation of EU in many countries requires the immediate shift in the banking industry. Prior to globalization, the European banks were decentralized.8 EU banks started to merge back when Euro was adopted in 1999. The integration of the national banking system is necessary in supporting the use of a single currency among the EU members. Through the integration of the banks, financial transactions that will come from the opening of domestic markets within all EU members will be less complicated. At the same time, these banks also adopted the domestic deregulation programs and a harmonized regulatory system that aims to maintain competition within the banking industry.8 The opening of the domestic markets to all the EU members is not the only reason behind the merger of banks, other factor such as tight competition in the global banking system, the benefit of economies of scale, the more complex business environment in both domestic and international financial transactions also contributes to the transition of the banking system in EU. EU Banking Regulatory Intervention The banking regulatory intervention adopted by the EU banks was designed to avoid domestic competition. This regulatory includes controlling of the interest rates and fees, credit controls, restriction on the entry of a possible new player in the banking industry, and by controlling the capital flows in each banks. In order to limit the range of banking activities and exploitation of the market share, banks are restricted to perform the selling of insurance and securities as well as regulating the maturity terms of loan and deposits. EU banks are also regulated to make these banks competitiveness by setting a capital adequacy requirements, deposit insurance schemes, solvency regulations, and restrictions on the ownership linkages with non-financial firms. Competition in the Banking Industry Based on H-statistic test that was conducted by Bikker and Haaf (2000), there is a strong evidence that the banking markets in an industrial world are characterised by a monopolistic competition.9 However, there are times when banks could not exclude a perfect competition. The size of banks matters when it comes to being competitive. Normally, small banks may not be able to compete with medium-size or large banks because of its limited resources. This is partly because small banks can offer only limited services to the public. This is the main reason why most small and medium-size banks chose to enter into partnership or merger. Concentration Ratio in EU Banks Based on the literature ‘Structure-Conduct-Performance-Hypothesis’ (SCP), the higher the concentration in the banking industry means that the bank could generate more market power by allowing the banks to earn from a monopolistic profits. On the other hand, a high concentration in the banking system can also result to a greater efficiency considering a larger market share.10 It means that for banks to be able to compete in the global world of banking and finance higher concentration ratio is important to achieve a better efficiency in services offered as well as a bigger profitability for them. Prior to the EU agreement and globalization, the banking system of these countries are most likely to be less concentrated or oligopoly because the barrier to entry of banking industry was low. This is possible because the government in each EU members implemented a less restriction in their local banking system. Because of the limited power of the banks, most of these small and medium-size banks are operating domestically. According to Gual (1999), in case banks were engage in a competition – either by controlling the price and the quality of the customer service; the European banking industry is likely to remain moderately concentrated despite the banking integration that has been visible in the past few years. He added that the concentration in the banking industry is likely to increase at the national and EU level in case competition focuses on endogenous sunk costs such as the development of a brand image, establishing a strong capital base, or through investment in electronic banking.8 Conclusion The transition of trends in the market and economic activities over the past few years had caused major changes in the concentration ratio of the banks in European Union. The market situation that has resulted from the EU agreement and globalization requires the current EU banking system to open more bank branches in relation to providing efficient services to its customers. In order for the small and medium-size banks to compete with the larger banks including the international banks, these banks need to come up with a merger agreement. This will enable them to have more power and capabilities to sustain the demand that is required by the competition within the banking industry. Today, the banking industry of EU is more concentrated as compared to many years back. This higher concentration in the EU banking system will enable these banks to be able to cope with the challenges set by the globally competitive world of banking and finance. *** End *** References: 1 CIA (2007) ‘European Union’ Retrieved: April 10, 2007 < https://www.cia.gov/ > 2 Agarwal, J.P. (1996) ‘Impact of Europe Agreements on FDI in Developing Countries’ International Journal of Social Economics. Vo. 23 (10/11): 150-163. 3 Meunier, S. and Nicolaïdis, K. (2006) ‘The European Union as a Conflicted Trade Power’ The Journal of European Public Policy. Vol.13, No.6. September 2006. pp. 906 – 925. Retrieved: April 11, 2007 < http://www.princeton.edu/ > 4 OECC (2007) ‘OECD Statistics: Unemployment by Duration’ Retrieved: April 11, 2007 < http://stats.oecd.org/ > 5 Meunier, S. (2005) ‘Trading Voices: The European Union in International Commercial Negotiations’ Princeton, NJ: Princeton University Press 6 OECD (2006) ‘Recent Trends in Foreign Direct Investment in OECD Countries’ April 11, 2006 Retrieved: April 11, 2007 < http://www.oecd.org/ > 7 Artis M. (2006) ‘The UK and the Eurozone’ CESifo Economic Studies Retrieved: March 29, 2007 < http://cesifo.oxfordjournals.org/ > 8 Gual, J. (1999) ‘Deregulation, Integration and Market Structure in European Banking’ October, 1999 Retrieved: April 12, 2007 < http://www.iese.edu/ > 9 Bikker, J.A. and Haaf, K. (2000) ‘Competition, Concentration and their Relationship: An Empirical Analysis of the Banking Industry’ Retrieved: April 12, 2007 < http://www.eco.rug.nl/ > 10 Demsetz, H. (1973) ‘Information and Efficiency: Another viewpoint’ Journal of Law and Economics 10, 1 – 22. from Yildirim and Philippatos (2003) ‘Competition and Contestability in Central and Eastern European Banking Markets’ Retrieved: April 12, 2007 < http://129.3.20.41/ > Read More