The Empirical Analysis of Measuring Competition in Australian Banking Sector - Example

Results Panzar-Rosse H-statistic Results II ROA Predictor Coefficient T P Coefficient T P Constant 6.4367 8.22 0.000*** 0.0273 2.54 0.013 AFR 0.5541 2.96 0.004*** 0.0048 2.49 0.015 PPE -0.9248 -4.86 0.000*** -0.0029 -1.95 0.056 PCE 0.2378 2.30 0.024** 0.0012 1.24 0.218 LNS/TA 0.6976 1.42 0.161 0.0169 2.85 0.006** DPS/F 0.3903 1.50 0.137 0.0005 0.23 0.816 EQ/TA 0.7933 3.29 0.002** 0.0034 1.37 0.174 OI/II 0.0614 0.46 0.644 0.0049 3.69 0.000*** H -0.1329 0.0031 Wald Test F=0 0.18 0.6719 1.09 0.3011 Wald Test F=1 13.16 0.0005*** R2 0.9830 0.7958 Adj. R2 0.9788 0.7455 Number of Observations 85 85 Significant at 1% level ** * Significant at 5% level * * Significant at 10% level * The above table illustrates the competitive setting in Australian banking industry. The unscaled H-statistic is less than 0 and this shows that the Australian banking market setting illustrates monopoly behavior. On the other hand, the H-statistic for long-run equilibrium is 0.0031 and this is almost 0 and hence show the information fits the long run equilibrium criteria. The staff expenditure is variable and negative and hypothesized that the Australian banks have decreased their labor expenditure and this can be attributed to increased innovations and technology within the Australian banks. According to the results, the three factors input variables have statistical significance. From the Wald tests, the F-statistic for H=0 at 5/10 % significance. The H value has no statistical significance variation from 0 and hence it can be hypothesized the Australian banking industry might have oligopoly or monopoly competition. The test for long-run equilibrium generates H-statistic of -0.0022 and this is almost 0. Wald test also shows that the statistics met the long-term equilibrium. Discussion The P-R model was used in measuring the competition within Australian banking industry. The model gives a measure between 0-10 of the level of competition within an industry/market. Calculation of the P-R model is done from a reduced form profit equation and hence it can effectively measure the total elasticity of a company’s total revenue against the company’s input prices. According to Schaek & Cihak (2008) competition within the banking industry is typified by monopoly for H ≤ 0, monopolistic competition/oligopoly for 0 < H < 1, as well as perfect competition, for H = 1. The tables below illustrate the discriminatory power of H: Values of H Competition Competitive Environment Test H ≤ 0 Monopoly equilibrium: operations of every distinct bank is independent just like under monopoly profit-maximization conditions (H is a reducing function of the apparent demand elasticity) Perfect oligopoly Hypothetical deviation short-run oligopoly: The number of companies within the market is secured and the basis of decisions that every company makes is on conjectures regarding how and what other company’s responses will be towards its own behaviors and actions 0 < H < 1 Monopolistic competition and this implies that there free entry equilibrium (H is an escalating function of the apparent demand elasticity). Distinct companies face an in-elastic demand curve and this means that the increase of proceeds is comparatively less than changes within factor input prices. H = 1 Perfect competition and this means that there is free entry equilibrium and the competence is exploited fully Natural Monopoly within a perfectly competitive industry Values of H equilibrium Equilibrium Test H = 0 Equilibrium H < 0 Dis-equilibrium (Panzar & Rosse, 1987) The data indicates that Australian banking industry fall in monopolistic / oligopolistic behavior. This is based on all the explanatory variable factors that were analyzed. H is interpreted as a constant measure of the competition, principally between 0-1. When the values of H are higher, this shows that the competition is high while lower values of H indicate that the competition is comparatively low. The monopolistic behavior of the Australian banks may indicate healthy competition (Schwartz & Carr, 2013). However, as the results indicate, the most common form of competition in Australian banking industry is oligopoly. Oligopoly indicates that the Australian banking industry does not have strong competition. Shaffer (2015) explains that oligopolies tend to have weak competitions because they are in a position to utilize pricing power to the disadvantage of customers. In addition, the pricing power gives the banks the ability to avoid competition with the smaller banks (Schwartz & Carr, 2013). The banking system within Australia is oligopoly. The four major banks within Australia have key pricing power, which is higher than standard returns on equity and big market shares. The lack of strong completion within the Australian banking industry has had major negative effects for the economy of Australia and the customers as well. This is because the lack of competition creates a perspective of some banks being deemed as being “too larger-to-fail and also does not encourage banks to innovate and invest in new infrastructure (Kumbhakar et al, 2009). The literature review indicated that competition promotes innovation since it provides organizations with an opportunity to differentiate their products and make new innovations in order to attract more customers and hence increase market share (Perera et al, 2006). For instance, with high competition banks are likely to invent applications and products that facilitate convenience and accessibility of their products for their customers (Perera et al, 2006). In addition, as aforementioned, the lack of strong competition within the Australian banking industry has allowed the large banks to utilize their pricing power to get more and excess profits from customers. This is in line with Schwartz & Carr (2013) who explain that pricing power is among the strongest indicators of an oligopoly. This is evident in Australian banking industry where the four big banks possess significant pricing power. The major Australian banks have successfully lifted standard interest rates all over the economy and as a result the banks pass the increased costs to the customers. Accordingly, Australian banks do not always compete forcefully for increased market share (Schwartz & Carr, 2013). As indicated by the results, Australian banking industry has monopolistic / oligopolistic behavior and hence the competition is not strong. According to Schwartz & Carr (2013) the not so strong completion within Australian banking industry is depicted by few new entrants into the market and also a few mergers and exits during the last few years. Within the market, completion is perceived to be strong if there are new entrants into the market and few barriers to entry. The Australian banking market can be perceived as weak in regard to competition because the barriers to entry are comparatively complicated and can high for even players who have strong financial backing (Shaffer, 2015). This makes it even worse for players without extremely strong financial backing and this is the reason small banks within Australia are not able to compete with the major banks. High barriers to entry in the Australian banking market are one of the factors that hinder competition in this industry. These barriers occur due to the regulatory as well as commercial grounds. For example, to operate as a bank within Australia, the banks are required to get a banking license from APRA. After obtaining the license, the bank is required to confirm to the APRA’s cautious prerequisites, constantly (Schwartz & Carr, 2013). As per the Financial Sector Act 1998, a shareholder is not supposed to have more than 15% of the potential ADI’s voting shares devoid an exemption. On hand ADI, especially the large banks possess large quantities of customer and business information and this allows the major banks to use the data to precisely model and price risk. This is in line with Davis (2007) who adds that existing ADIs, especially the large banks posses strong brands and refined allocation networks whose replication is costly. In addition, barriers to exit in Australian banking market are also high because before a bank exits the market, it is evident that there is low likelihood of market participants acquiring the business that is being exited (Deloitte, 2014). In regard to competitiveness as per the banks’ size, the competition is more predominant in the large banks and medium-sized banks when compared to the small banks. Loans to assets ratio was among the factors used in measuring the competiveness of the banks. For the Australian banks, loan is among the most significant factors, in regard to the occurrence as well as significance level. As the literature review indicated, the ratio of loans and total assets, as proxy of risk is a crucial element of the sum of the interest income. According to Deloitte (2014) the demand for real loan has negative correlation with the loans’ price, the lending rate. Demand for loans also has positive correlation within the rising investment activity as illustrated by increased capital usage rate. A high profit income share is an indication that the bank has high profitability and high prospects of future profitability and therefore attracts investors and increases demands for new loans. This as a result allows such banks to have higher profitability. However, Shaffer (2015) opines that when the profitability is high, it is possible to fund new investment activities and therefore this weakens the demand for loans. The reason as to why loan supply impacts competition is that loan supply impacts the lending rate, inputs like wages, and also other exogenous variables like money market rate. Jimenez et al (2007) support this and explains that loans to assets ratio is an important measure of competition of the loans market. This is because bank convert the risk allied to bigger loan portfolio into higher prices. Moreover, the weak competition in Australia can be associated with the fact that the four major Australian banks have already taken a big market share. The reviewed literature indicated that the larger banks are able to generate higher profits from their assets and hence they are able to diversify and increase their market share (Bikker & Haaf, 2000). This explains the domination of the market share by the four major banks. The major banks in Australia hold more than 80% of home mortgages and this is one indication of how the major banks in Australia hold a high percentage of the market share (Senate Economics Reference Committee, 2016). The study results indicate that the Australian banking market is reasonably concentrated. There have been a few bank mergers in Australia, and this indicates that the Australian banking industry has become extensively more concentrated. This is an indication that the major bank dominate the market and that smaller banks are not improving their market share (Leon, 2014). Generally, lack of strong competition within Australia can be attributed to factors such as the major banks with Australia having lower cost structure, the high barriers to entry into the banking industry as well as customer inertia (Deloitte, 2014). In regard to the lower cost structure, the financing and operation costs of the larger banks are relatively lower when compared to the medium and small banks. This is because the larger banks have significant vertical and horizontal integration and this offers the major banks big economies of scale. Australian Government (2015) further adds that large banks are TBTF and hence the major banks have excellent credit ratings because of the apparent government guarantee and this adequately reduces their financing costs when compared to other medium and smaller banks. For instance, the implicit guarantee is estimated to be approximately $3.7 billion for the large banks within 2015 and this indicates the significance of government guarantee when it comes to financing the major banks (Senate Economics Reference Committee, 2016). Customer inertia has also contributed to weak competition within the Australian banking industry. According to Schaek & Cihak (2008) customer inertia restricts efficient competition. Customers in Australia are disinterested in switching banks. Customer inertia can be attributed to the fact that the major banks in Australia already have established and loyal customers and hence switching rate is low. Low switching rates can also be associated with the high switching costs. As a result, customers are not willing to switch to other alternative providers even if they have better priced products. Basically, the major banks in Australia encourage customer inertia using non-transparent pricing and product bundling (Deloitte, 2014). However, the results indicate that H is significantly lower when the medium sized banks and small banks when compared to the major banks. Evidently, small and medium banks operate within a less competitive setting when compared to the major banks (Deloitte, 2014). Reference list Australian Government, 2015, Response to the Competition Policy Review, Australia. Bikker, J. A., & Haaf, K, 2000, Competition, Concentration and their Relationship: An Empirical Analysis of the Banking Industry: De Nederlandsche Bank. Bikker, J. A., Spierdijk, L., & Finnie, P, 2006, Misspecification of the Panzar-Rosse Model: Assessing Competition in the Banking Industry. 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