On the Implication of Market Power in Banking - Evidence from Developing Countries by Turk Ariss - Article Example

REFEREE REPORT By Referee Report Summary of the Article Market power has a very significant implication in the efficiency and stability of banking across numerous economies in the world. However, this is a rare occasion that concerned stakeholders realize the level of implication that market power has on both banking stability, as well as efficiency, more so in the third world or developing countries. Nevertheless, recent studies posture the fact that market power affects adversely the stability and efficiency of banking operations. The author of this article, “On the Implication of Market Power in Banking: Evidence from Developing Countries” explores a new world in the banking economy which lacks precedents on new establishments and applications on the field (Al-Jarrah & Gharaibeh, 2009). As such, she aims to examine the effect and implication that market power has on banking stability and banking efficiency in most developing economies. In addition, the author makes use of a wide range of dataset collected from 5 areas, 60 nations and 821 banks. The past literature reviews conducted on this paper provide that no affirmative verdict appears on the concepts of “competition and stability” as well as “competition and fragile.” The author managed to compound the efficiency-adjusted Lerner index, the traditional Lerner index, and the funding-adjusted Lerner-adjusted Lerner index (Al-Muharrami & Mathews, 2009). Advantages The arrangement of the article is so clear and precise that any reader or researcher can easily grasp the argument of the author, as well as capture the significant points in the article instrumental in boosting their quick understanding of the paper. This is one of the key observable strengths of the article. As such, a categorical analysis of the entire paper provides that the author develop a concise structure of the article by separating it into seven different parts. This enables readers of the article to identify her idea of development and writing the article is very persuasive, as well as systematical. For instance, from as early as the introduction part, it is possible for readers of the article to note the difference in opinion held by concerned stakeholders on the implication of market power on baking stability and banking efficiency. In order to strengthen her argument, the author quotes various pieces of literature from the supporting and the negative sides, such as Casu and Girardone, 2006 on one side against Delis and Tsionas, 2009; Schaeck and Cihak, 2008, Koetter et al., 2008; and Maudos and De Guevara, 2007. Disadvantages I hold no reservations pertaining the quality of the article. In fact, I am of the belief that the article is of extremely high quality, especially considering the fact that the author ventures into a new field without previously set precedents, as well as existing literature reviews exploring the topic. Nevertheless, I will not relent in mentioning a number of weaknesses notable in the article that the author needs to improve in order to exemplify the quality of the article. For instance, the introduction appears as though the author junks a lot of information that to some extent look bothersome, though this is useful to the development of the article. In fact, some of the literature reviews provided in the introduction are too technical and comprehensive for this part of the article (Berger & Hannan, 1998). As such, it may lead to further confusions on the reader as opposed to the understanding and knowledge he or she is supposed to gain from the article. Another visible mistake done by the author is her choice of 60 third world countries to review in her research study. However, the country list available in the article only provides three countries under BRICS, but excluding South Africa and China. This is wrong, as China is the largest developing country categorized under BRICS. On the other hand, South Africa, the largest developing country in Africa, also belongs to the middle-income developing countries thereby imperative to include in the analysis. Another failure of the article comes in the conclusion part whereby the author strives to create an impression of the existence of a positive relationship between market power and bank stability and bank efficient. In addition, the author also tries to establish the fact that this analysis finding is instrumental for policymakers in developing countries. The weakness of the paper stems from its failure to expound on the importance and relevance of this analysis or finding to the policymakers. This would in turn reduce the amount of pressure placed on the banking system (Floros & Tan, 2013). Another failure notable in this article is the application of three formats of Lerner Index to establish the bank-level measure of competition. This in turn investigates the implications that market power has on the efficiency of banks, especially on the developing world. As such, the report suggests that a positive relationship exists between market power and cost efficiency within the European banking system thereby rejecting the ‘quiet life’ hypothesis. This is wrong because a comprehensive analysis of relationship between market power and efficiency should consider both profit efficiency and costs efficiencies. It is imperative to note that banks can as well achieve higher profits through diversification of their revenue sources, aside from minimization of costs (Koetter, Kolari, Spierdijk, 2008). Furthermore, it is a notable fact that competition, which results from market power, enhances profitability within the banking sector. As such, the data selection for this analysis, especially from the developing countries was wrong since it failed to consider other economic aspects that affect the performance of banks, as is the case in the developed countries, such as in Europe and America. The data and variables used in the article are also short of the required standards for such an analysis. The data used by the author to compile the article was retrieved from bank-level financial statements for years between 1999 and 2005. The information was retrieved from the BankScope database provided by Fitch. IBCA (International Bank Credit Analysis) has a comprehensive coverage of the banking results in most countries. Therefore, the application of the different variables in this analysis, such as time and interest levels in each country fell short of undertaking a comprehensive analysis of the entire article. In addition, he selection of the Lerner Index model as the best alternative for estimating market power against bank efficiency and stability was somehow incorrect (Lui, Mirzaei & Moore, 2011). The best alternative for the researcher to use in this analysis is the Z index. The Z index is instrumental because it asses the overall stability at a bank level, and not on a general market scale as was the case with the Lerner Index model. As such, this proxy of bank stability combines the indicators of leverage, profitability, as well as return on volatility into one single measure. In addition, it also provides the necessary information on the number of standard deviation units by which profitability levels have to decline in order to deplete the capitalization rations (Rima, 2010). Conclusions and Recommendations The article structure is very good. The literatures used in the article are also very good as they assist readers in understanding the related school of thought to the topic. Additionally, the regression model results provide readers more reason to trust and believe in it, as well as adding a positive score to the paper. As such, the paper is an excellent piece investigating the effect of market power on banking stability and banking efficiency in developed countries, and the results provided enabling readers to have a better understanding of the topic. However, it is also imperative to note some of the failures discovered i the paper, which in turn reduce its quality and performance levels. The key disadvantages in the paper include the long introduction at the beginning of the article, taking nearly one quarter of the entire paper. This makes the pros of the paper irrelevant as the introduction offers too much information that may confuse the reader from the start, and as such, possible miss the whole idea of the paper. The choice of countries selected to undertake this analysis, mostly from developed countries is also faulty. This is regarding the fact that it leaves out China and South Africa within is comparative analysis of countries belonging to BRICS, yet these two are somewhat the pillars of within their respective economies. The conclusion of the paper fails to stamp authoritatively the effect of market power on banking stability and efficiency, thereby a slump in convincing decision makers in most developing countries to adopt this report and apply it when making critical financial decisions affecting their economies. Reference List Al-Jarrah, I. & Gharaibeh, H. (2009). The Efficiency Cost Of Market Power In Banking: A Test Of the “Quiet Life” And Related Hypothesis in the Jordan’s Banking Industry. Investment Management and Financial Innovations, Volume 6, Issue 2, 2009. Al-Muharrami, S. & Mathews, K. (2009). Market Power versus Efficient-Structure in Arab GCC Banking. Cardiff Business School, E2009/7. Berger, A., Hannan, T., 1998. The efficiency cost of market power in the banking industry: A test of the ‘‘quiet life” and related hypotheses. The Review of Economics and Statistics 80, 454–465. Floros, C. & Tan, Y. (2013). Market Power, Stability and Performance in the Chinese Banking Industry. Economics Issue, Vol. 18, Part 2, 2013. Koetter, M., Kolari, J., Spierdijk, L. (2008). Efficient competition? Testing the ‘‘quiet life” of US banks with adjusted Lerner indices. Working Paper, Groningen University. Lui, G., Mirzaei, A. & Moore, T. (2011). Does Market Structure Matter on Banks’ Profitability and Stability? Emerging Versus Advanced Economies. Brunel University London, Department Of Economics and Finance. Working Paper No: 11-12. Maudos, J., De Guevara, J., 2007. The cost of market power in the European banking sectors: Social welfare cost vs. cost inefficiency. Journal of Banking and Finance 31, 2103–2125. Mirzaei, A. The Effect of Market Power on Stability and Performance of Islamic and Conventional Banks. Schaeck, K., Cihak, M., 2008. How does competition affect efficiency and soundness in banking? New empirical evidence. Working Paper No. 932, European Central Bank. Turk Ariss, R. (2010). On the Implications of Market Power in Banking: Evidence from Developing Countries. Journal of Banking and Finance 34: 765-775 Read More