To What Extent Is the Spanish Banking System an Oligopoly - Research Paper Example

To what extent is the Spanish banking system an Oligopoly This paper examines the two set of arguments -one, based on historiography and the other, based on econometric models that have examined the presence or absence of oligopolistic markets in the Spanish banking industry. This paper concludes that while historiography has narrated events that give compelling evidence of a few major players consolidating and emerging; the econometric evidence collected in deregulated Spanish banking industry, does not reveal significant oligopolistic formation or practices. ___________ ____________ ____November 2007 To what extent is the Spanish banking system an Oligopoly Introduction Globalization has brought about the integration of the world markets. In this sense the global market place has tended to move towards a perfect and pure market structure as defined in the economic theory; however the exact form of global markets have remained far from the theoretical ideals of perfect and pure. Irrespective of the product or service that is being studied; it is apparent that all of a sudden the information flow has become more rapid, regulatory structures more oriented to free market structures and the movement of capital and permission to access local markets freer. This has prompted national businesses to target global businesses and the global businesses to target national markets. However lumpiness in the control of market shares is seen as yet which has tended to be diluted monopoly or monopolistic controls of the past and the structures have tended to turn, in general, to oligopolistic structures. Banking industry is no exception. Main features of banking industry, irrespective of jurisdiction have been a long standing history of business, ready demands for its products and services (baring economic downturns) and specific protection enjoyed from the national governments It has experienced a more benign and structured capital adequacy regimes in the form of Basle I and now Basle II apart from a host of other suggestive and market discipline based stipulations. Fact remains that banks enable target customers to do the essential functions of saving, investing and storing money or money equivalents and therefore banks tend to have a loyal and core segment of consumers on most jurisdictions where they have chosen to operate. Spanish banks are no exception. This has spurred market control strategies from the banks and these strategies coalesce to determine as to what exact form of market does the banking industry of a particular time looks like. Literature has often pointed out to the extent of competition in the banking industry: "Competition has become a recurrent topic in the banking literature. Specifically, during the last decade a great deal of empirical work has attempted to measure the level of competition prevailing in European banking markets. The beginning of the third stage of the Economic and Monetary Union, in January 1999, and the projected changeover to the Euro triggered the interest of researchers in this issue" (Rozas, 2007). This paper has the objective of examining the Spanish banking industry and to ascertain, if over the years, such an industry has come to acquire the market form of an oligopoly. This done through an in depth literature review where major arguments are sourced and analyzed and conclusion arrived ,on the basis of such an analysis, if the present day Spanish banking industry resembles a oligopolistic structure. Research Methodology Competition studies in banking industry of various jurisdictions is a very well thought out and researched topic and the literature in this area is rich with several aspects being already examined through deep empirical and theoretical research. Literature also has in store several models of depicting the shape and structure of the markets in which banking industry of a particular jurisdiction finds itself apart from listing and analysis of the various important factors that have caused the present shape and structure of the market. This research would aim at narrowing down arguments that lead to consensus on the possible market structure in which the Spanish banking industry finds itself in present day. The literature review would be deployed to gather arguments to substantiate above research objectives and to establish arguments in the research. This research methodology was a detailed, descriptive analysis of the arguments presented in the available research evidence. The research method essentially entailed conduct of intensive interrogation of published documentary materials with the explicit aim of addressing the above stated issues which this paper deals with, providing a critique of existing theory and positions. Standard search approaches were used to retrieve the sample of published and unpublished studies for this in-depth literature review. Appropriate on-line journals were also searched. Citations in bibliographies of identified studies were reviewed to uncover additional references. Retrieval using the ancestry method was used as it is a most fruitful approach. The overall view of the literature review based research method would be a view usually taken in phenomenology. Phenomenology is a science which focuses on describing particular phenomena as lived experience. The method gives us a description of that experience as it is (Merleau-Ponty, 1962). Herbert Spiegelberg (1975) defined phenomenology as the procedure with main aims of direct investigation and description of phenomena as experienced. Phenomenology has been described both as a philosophy and a method at the same time (Spiegelberg, 1975; Merleau-Ponty, 1962). Phenomenology is considered a more appropriate design in the present context as it would help address (describe and explore) the phenomena of the evolution of the market structure of the Spanish banking industry across time and under several influences-positive or negative. This evolution of the market structure was viewed as a phenomenon. Literature Review & Analysis Oligopoly is a market structure in which a few sellers dominate the market and the equilibrium price determination is dependent on the level of cooperation or conflict between the sellers. Conflict versus cooperation is reflected in quoting prices. Due to interdependence of the two sellers it becomes very important for each firm to decide strategically whether to quote a low or a high price. In Bertrand oligopoly strategy reduces to simultaneously setting prices in the hope that the competition does not change its set price. Such conflicting or non cooperating pricing strategies are increasingly being dealt with the constructs in Game Theory which not only introduced the idea that conflict could be mathematically analyzed but also provided the terminology with which to do it. Rasmussen (2001) traces the beginning of the theoretical development in field by quoting the relevant literature and by stating that the evolution of the arguments around the "Prisoner's Dilemma" construct (as in Tucker) and thereafter Nash's papers on the definition and existence of equilibrium further developed the field of the modern non-cooperative game theory. However important and simultaneous developments were taking place in cooperative game theory through the important contributions of Nash and Shapley on bargaining games and Gillies and Shapley on the core theory utilized in study of cartels. These developments are traced in several books on economics and Game Theory. (Thus if each firm acts independently, the result is a Nash equilibrium. Part of the definition of Nash equilibrium is that each player takes what the other players are doing as given when deciding what he should do; he holds their behavior constant and adjusts his to maximize his gains. But if one firm increases its output, the other firms must adjust whether they choose to or not. If they continue to charge the same price, they will find that they are selling less; if they continue to produce the same amount, the price they can sell it for will fall. Shepherd & Shepherd (2004) states that, "Oligopoly therefore also involves indeterminacy, because it provides a whole range of possible outcomes. Outcomes vary because there are infinite varieties of both oligopoly structures, which differ in concentration, inequality among leaders, and other elements, and attitudes and motives among the leading firms. The shining hope of theorists has been to find deterministic solutions to the slippery, smoke-and-mirrors indeterminacy of the oligopoly problem." The authors, in exploring some of the chief game theory approaches to oligopoly state "However, game theory has not yielded a single model to explain oligopoly." (p. 228) In case of the Spanish banking industry the presence of a cartel of banks that hold a good share in the market and their collusive pricing and distribution of the banking products can lead to a conclusion of the presence of an oligopoly. In free interest rate regimes (a price element for banks on the supply side of funds) can leave a tell tale sign of the presence of an oligopoly. Pricing strategies in an oligopoly are interactive and follow the mechanics of the game theory, as explained above, an indication by the Central Bank of a dear money policy, for instance can lead to a chain of interest rates hikes by the individual market participants. If such strategic decisions, particularly among major players, tend to become interactive in the sense that an initial hike by one player leads to fine tuning hikes by others and the process goes on till market equilibrium is reached or the Central bank intervenes; then it would be easy to conclude that banking products' markets are oligopolistic in nature. This pricing pattern relies on the fewness characteristic of the oligopoly. Oligopoly exists when a few firms dominate the market for a good or service. This implies that the firms are mutually interdependent and that each must consider the possible reactions of rivals to its price, promotion and product development decisions. It must be once again recollected that the Spanish banks are operating in the globalized market view and their strategies-whether oligopolistic or otherwise- aim now at global market shares. New technological developments, improvements in communication, growth in transnational infrastructure and liberalizing of trade and capital flows have enabled entrepreneurs the globe over to deploy and run their capitals chasing markets the globe over. The globalization aligned attitudes of IMF and World Bank are exemplified with clarity by Jean-Claude Trichet, President of the European Central Bank, when he says that," The key aim of today's policy makers has not changed compared to those at the Bretton Woods times - it has been, and still is, global prosperity and stability - but the environment in which we are acting has changed profoundly......Today we are striving for stability of the international financial system in a world of free capital flows with a growing importance of private flows and increasing trade and financial integration"(Trichet, 2004). Literature has also been quite clear about the internationalization of the Spanish Banking system: "The Spanish banking system bears witness to the increase in international financial integration that has taken place in recent years. A key contributing factor to this phenomenon was the complete liberalization of capital flows in February 1992. The concept of internationalization is nonetheless sometimes ambiguous. Globalization, market integration and advances in information technology upon which the banking industry is highly dependent do not necessarily require a physical presence in order to achieve some degree of internationalization". (Miguel and Hernansanz, 2000). It is also accepted that first attempts at globalized markets are made by those that are fittest to make such attempts, In case there is a concentration in acquisition of global markets by a few national players then an oligopolistic domestic market has to be a most probable conclusion. Guilln & Tschoegl (1999) present a compelling evidence in this respect in case of the Spanish Banks in latin America, using the literature support, in following words, " Since 1995 three Spanish banks-Banco Santander (Santander), Banco Bilbao Vizcaya (BBV), and Banco Central Hispano (BCH)-have become the largest foreign banks in Latin America. (In 1999 Santander and BCH merged to form Banco Santander Central Hispano - BSCH). These banks have spent over US$4 billion to acquire large stakes in almost 30 major banks in more than ten different countries (Table 1) accounting for some US$40 billion in assets. Moreover, Table 1 does not include the numerous acquisitions of credit card, consumer and commercial loan, insurance, stock brokerage and pension fund management companies, or earlier acquisitions and pre-existing operations. What is novel about this expansion is that the Spanish banks are acquiring some of the largest domestic banks in their target countries and entering the general commercial and mass retail market. Furthermore, the stock market seems to have endorsed this strategy. Of the world's 50 largest banks (in terms of market capitalization), BBV (at 56%) and Santander (47%) ranked 1st and 3rd in terms of total stockholder returns between 1993 and 1998 (The Banker, July 1998, p. 20). The recent turmoil in emerging markets reduced the banks' valuations but this reflects judgments about the markets and not necessarily about the banks' activities". The literature further supports the oligopolistic internationalization of the Spanish Banking Industry in following words: "Between 1996 and 1999, the consolidated financial assets of the Spanish banking system increased by 62 %, compared with the 8 % decline registered by the non-consolidated data. These data therefore reveal an intensification of the process of bank internationalization over recent years, over and above intra-group transactions". (Miguel and Hernansanz, 2000). The above facts and figures do definitely point out to cartelization and presence of oligopolistic control amongst Spanish banks. Another reason for the banks to operate out of a cartel like oligopolistic formations is the sensitiveness of the banking business to panics reactions among depositors and investors. Such panics can result in run on the banks and can mean collapse of business for banks. Several research papers have studied the effect of the panics on the banking system and focused on enumerating the timing and geography of bank failures during panics (Wicker,1996).While some other research efforts have attempted to explain if panics were one time abnormal periods that resulted in the failure of even solvent banks by comparing banks that failed in panic periods to banks that failed outside such periods and finally tracing the survival of some such banks (White,1984) and (Calomiris and Mason,1997).The former paper arrives at the conclusion that banks failing during panic periods were weaker than banks that survived and not quite similar in financial characteristics to banks that failed during non-panic periods. Literature has identified four major panics were identified in the Great Depression period (1930-1933). Friedman and Schwartz attribute the 1930 panic to a contagion of fear" caused by the failure of a major US bank (Friedman and Schwartz, 1963). Digging the historiography based popular trend of presence of an oligopolistic market structure literature has often attributed such market structures to various factors .For instance consider this literature piece which states that, "The monopoly hypothesis was devised on the grounds of the main characteristics of the Spanish economy in the first decades of the twentieth century. Its long-lasting economic backwardness involved a correlative immaturity in both financial markets and markets for goods and services. Consequently, economic and political agents reacted in a defensive manner. Governments set up an economic policy aimed at isolating domestic markets from the international economy, so Spanish businessmen could rely upon narrow but protected markets to achieve a handsome return on their investments".(Pueyo ,2007). The above analysis carries on the reasoning from early governmental protection to government financing as some of the causes for promoting only a few banking players in Spain in following words, "The starting point in the process of cartelization was dated in the First World War years. The international situation provided an implicit protection for the Spanish firms, which took advantage of neutrality and collected an amazing amount of profits. Funds flowed into banking deposits where they were hoarded because uncertain and pessimistic prospects at the end of hostilities curbed real investment. Simultaneously, governmental expenses got out of control without a parallel increase in tax revenues, so the public deficit reached extremely high amounts. In 1918, an initial agreement between banks accumulating idle funds and an exhausted government would become plain with the early issues of a new type of public bonds".(Pueyo ,2007). In fact, the history of oligopolistic structures in the Spanish banking industry has been generally cited in relation to certain banking products that were essentially used by the government to support its own financing programmes. The banks were used as vehicles to promote and subscribe to such products and there was a symbiotic relationship between the banks and the government to start with in which the banks supported government's bonds programmes and the government in turn ensured the perpetual existence of banks through permissions, license and additional capital support. Banks also consolidated their position by way of earning fees and underwriting commissions. This hiked up the bottom-line of the banks. As this literature study states very clearly that "Banks committed themselves to underwrite the whole issues, provided that the government guarantees their liquidity. As capital markets were underdeveloped, the government established that public bonds could be pledged in the central bank as collateral for credits at the holder's free will. The credits would amount to 80-90 per cent of the face value of the securities, without the possibility of being denied by the central bank. Therefore, the private bank's portfolio of public debt became an extremely liquid asset because it gave direct access to the coffers of the central bank. Consequently, in the following decade banks could invest in all types of businesses without being worried about the risk involved in these operations". (Pueyo ,2007). In fact it is very important to examine the history based arguments for finding evidence of oligopolistic markets in Spanish banking industry. These arguments are furthered by following observation by Pueyo "As capital markets were underdeveloped, the government established that public bonds could be pledged in the central bank as collateral for credits at the holder's free will. The credits would amount to 80-90 per cent of the face value of the securities, without the possibility of being denied by the central bank. Therefore, the private bank's portfolio of public debt became an extremely liquid asset because it gave direct access to the coffers of the central bank. Consequently, in the following decade banks could invest in all types of businesses without being worried about the risk involved in these operations. This arrangement would have helped a very short number of large entities, which grew by means of take-overs and branching, presumably over a backcloth of collusive pacts agreed within the CSB. This council was established by the 1921 Banking Act and would become the forum where banks succeeded in agreeing the rules of the game in financial markets. In fact, the 1921 Banking Act itself is regarded as the bedrock of collusion among banks and with the government". (Pueyo ,2007). Pueyo then goes on to nail the oligopolist markets by identifying major players and pointing out to their joint and collusive strategy making in following words "From 1962 onwards, the chairmen of the seven large banks met regularly to coordinate their actions. The main conclusions coming up from the aforementioned paper coincide with the Stigler's explanation of the functioning of any typical oligopolistic market. Certainly, firms have incentives to collude but, subsequently, to cheating on the agreement. This way, the industry would go through succeeding stages of collusion and rivalry. In the case of the Spanish banking industry after the civil war, private firms would have been incapable of sustaining collusive agreements, even when they had governmental support". (Pueyo ,2007). The historiography arguments in support of the oligopoly market structures in the Spanish banking system are essentially interspersed with the description of events that have taken place over the time with emphasis on acquisition of bulk business at below market rates by such banks owing to such events. However, the concentration of market share and unusual efficiency or productivity in business operations apart from extraordinary profitability have been the focus of econometric studies which have attempted to measure these outcomes for Spanish banks over the time and conclude on oligopolistic structures. In this respect Rozas(2007) comments extensively with support from literature as follows, " The first Spain-only study was undertaken by Maudos and Prez (2003), who focused on the period 1992-1999. Using a sample of commercial and savings banks, their investigation leads to conclude that competition decreases during the period under consideration (the full-sample estimation of the H-statistic is 0.71). They buttress their findings with the calculation of Lerner indexes, used to proxy the level of market power exerted by banks. Last of all, Garrido (2004) assesses the degree of competition among Spanish banks between 1994 and 2000 employing a wide variety of econometric techniques. In spite of the instability of least squares estimates for separate years, results are in keeping with monopolistic competition. Furthermore, during the last period under study the level of competition decreased, confirming conclusions reached by other authors. Following Maudos and Prez (2003) and Bikker and Haaf (2002), the level of competition is also measured separately for commercial and savings banks, on the one hand, and for large, medium-sized and small banks, on the other. Summing up, this compilation of articles seems to provide ample evidence supporting the hypothesis that monopolistic competition, albeit to varying degrees, is the prevailing environment among Spanish banks. In fact, monopolistic competition is quite a recurrent finding owing to the wide range of values the H-statistic can take within this scenario (between zero and unity)". Rozas(2007) also gives a neat summary of the outcomes of the studies that deployed the Panzar-Rosse model in testing oligopolistic structure for Spanish banking system. The findings are presented in Annexure I. Conclusion Looking at the evidence presented both from the historiography and the econometric studies it can be concluded that there have been compelling circumstances that have led to directing bulk revenue earning business towards a few banking players which helped them consolidate their position in terms of size and profitability. Upon deregulation of the banking industry the major players have tended to cooperate with each other in attempt to prevent crisis ;however, the market capturing strategies have implied that the collusive arrangements were interspersed with events of deviations (called cheating in oligopoly language) where individual members tried to outperform others by taking trend setting decisions. It is immaterial that these were followed by others sooner than later. However concentration levels, profitability and efficiency levels have tended to move within a narrow band and several studies have been compiled which support an H statistic (Annexure I) that does not proclaim an outright oligopolistic market for Spanish banks. As Rozas(2007) comments with literature support, "An alternative explanation would consider instead that large banks are closer to long-run equilibrium than smaller banks, which presumably embrace new arrivees [Shaffer (2004)]. If that is the case, a greater value of the H-statistic does not reliably imply that the former behave more competitively. However, since the long-run equilibrium condition has been successfully verified for the entire sample of banks, this criticism does not apply. Moreover, this encouraging finding, which deserves to be regarded as the foremost contribution of the analysis, discredits the widespread hypothesis which states that large banks are prone to perform non-competitively, as it would have led to a lower value of the P-R indicator". Work Cited Rozas Luis Gutirrez de.(2007). Testing For Competition in the Spanish Banking Industry: The Panzar-Rosse Approach Revisited. Documentos de Trabajo N. 0726.Banco De Spana. Merleau-Ponty. (1962). Phenomenology of perception. (C. Smith, Trans.). New York: Humanities Press. Spiegelberg, H. (1975). Doing phenomenology. Dordrecht, The Netherlands: Martinus Nijhoff. Rasmusen Eric (2001). Games and Information: An Introduction to Game Theory. Third Edition, ISBN: 0631215573. Shepherd William G. and Shepherd Joanna M. (2004). The Economics of Industrial Organization. Fifth Edition, Waveland Press, p. 227. Trichet, Jean-Claude.The international financial architecture - where do we stand Speech by Mr. Jean-Claude Trichet, President of the European Central Bank, at the Conference "Dollars, Debt and Deficits - 60 Years after Bretton Woods". Madrid.14 June 2004. Pueyo Javier .(2007).Assessing competitive conditions in Spanish banking industry during Franco regime.A paper presented at the Third Iberometrics, Valencia,March 23-24, 2007. Sebastian Miguel and Hernansanz Carmen .(2000).The Spanish Banks' Strategy in Latin America.Vienna: SUERF (SUERF Studies: 9) Guilln Mauro F. & Tschoegl Adrian E. (1999). At Last The Internationalization Of Retail Banking The Case of the Spanish Banks in Latin America. Financial Institutions Center.Wharton. Wicker, E. (1996)."The Banking Panics of the Great Depression". Cambridge University Press, New York, New York. White, E. (1984)."A Reinterpretation of the Banking Crisis of 1930," Journal of Economic History. Calomiris, C., and J. Mason (1997)."Contagion and Bank Failures During the Great Depression: The June 1932 Chicago Banking Panic," American Economic Review. Friedman, M., and A. Schwartz (1963)."A Monetary History of the United States, 1867-1960". Princeton University Press, Princeton. Maudos, J., and F. Prez (2003). "Competencia versus poder de mercado en la banca espaola, Moneda y Crdito,217, pp. 139-166. Garrido, A. (2004). El grado de competencia en el sistema bancario espaol, Universitat de Barcelona Working Paper. Bikker, J. A., and K. Haaf (2002). "Competition, concentration and their relationship: An empirical analysis of the banking industry", Journal of Banking and Finance, 26, pp. 2191-2214. Shaffer, S. (2004). "Comment on "What drives banking competition Some international evidence", by Stijn Claessens and Luc Laeven, Journal of Money, Credit, and Banking, 36 (3), pp. 585-592. Annexure I Source: Rozas Luis Gutirrez de.(2007). Testing For Competition in the Spanish Banking Industry: The Panzar-Rosse Approach Revisited. Documentos de Trabajo N. 0726.Banco De Spana. Read More