Banking; analysing through economics the Spanish banking system - Essay Example

Table of Contents Introduction......................................................................................................................02 Literature Evaluation & Analysis.....................................................................................04 Oligopoly and Banking.....................................................................................................06 Oligopoly and Banking Sector in Spain............................................................................07 Conclusion........................................................................................................................13 Table of Contents 1 Bibliography 14 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 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. Regardless of the product or service that is being studied; it is noticeable that all of a sudden the information flow has become more rapid, regulatory structures have been oriented more towards free market structures and the movement of capital and permission to access local markets has become freer. This has encouraged national businesses to aim to be global businesses and the global businesses to target national markets. However, the roughness in the control of market shares in the past has tended more towards monopolies but, structures have not stayed the same, these have become, in general, oligopolies. This aspect of globalisation has thus changed the very nature of competition and the markets will move forward into a new direction of perfect markets if globalisations are sustained and its true objective is achieved. The Banking industry is no exception. Competition in the banking sector depends largely upon the efficiency with which financial services are produced, the quality of financial service produced and the relative degree of innovation in the sector. (Claaessens and Laeven). 1 This however depends upon how the banking sector competes with each other and what is the nature of the financial markets. This is important because the nature of the markets in the financial sector Banks enable consumers to do essential functions such as saving, investing and storing money or money equivalents. Therefore, banks tend to have a loyal and important segment of consumers on whatever jurisdiction they have chosen to operate in. The main features of the banking industry, regardless of jurisdiction, having been a long-standing business are; the ready demands for its products and services (With economic downturns), and protection enjoyed from the national governments. Moreover, because of this, feature it has experienced a more gentle and structured capital capability regimes. Due to the impact of globalisation on the banking sector, Spanish banks are no exception. This has urged certain market control strategies from the banks and these strategies unite to determine as to what exact form of market does the banking industry of a particular country and time look like. Economic Literature has always been able to point out the extent of competition in banking industries: “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)2. This paper has as an objective the examination of the Spanish banking system and the determination of it having acquired the market structure of an oligopoly with years. This will be done through a deep literature review where major arguments will be sourced and analysed in order to arrive to a conclusion; to see if the analysis resembles an oligopolistic structure in the Spanish banking system. Research Methodology Literature Evaluation & Analysis An Oligopoly is a market structure characterised by a small number of firms whose behaviour is interdependent. (Swann and McEacher)3.Due to the interdependence of the few sellers, it becomes very important for each firm to decide strategically whether to set a low or a high price and Conflict versus cooperation is reflected in price figures. For example, Bertrand competition4 suggests an oligopoly strategy where prices of one firm are set hoping that the competition will not change its set prices. Game Theory (the decision that a firm in an Oligopoly makes are based on the assumptions that it makes of thee competitor firms) constantly deals with such conflicting and non cooperating prices strategies. It also introduces the idea that conflict can be mathematically analyzed. Rasmussen (2001)5, outlines the beginning of this theoretical development in the field by stating how the arguments of the “Prisoner’s dilemma” are constructed and follows to quote Nash’s papers on the definition and existence of equilibrium in the modern (competitive) game theory. However, very important and immediate developments took place in the (cooperative) game theory with contributors like Nash and Shapley in the bargaining games and, Gillies and Shapley in the study of cartels (when firms collude and act like a profit maximizing monopolist). These special developments are present in books of economics and Game Theory. However, Oligopoly needs to be viewed in different approaches also. Historically, Oligopoly is being viewed under four different approaches. Cournot’s Oligopoly was a mathematical approach and is largely considered as mathematical model of Oligopolistic competition which gradually shifted its focus on the study of institutional and industrial organizations. The subsequent periods saw the emergence of a neoclassical theory of Oligopoly which was finally overcome by a more robust model of behaviors which included the study of new industrial organizations and gaming experience. (Shubik) The notion of price leadership and price rivalry within the framework of Oligopoly suggest that 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 and losing profits. Furthermore, 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. Pricing strategies in an oligopoly are responsive and follow the procedures dictated by Game Theory, as explained above. The pricing pattern relies on the few characteristics of an oligopoly. An 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. The shining hope of theorists has been to find deterministic solutions to the slippery, smoke-and-mirrors indeterminacy of the oligopoly problem." Exploring the principal Game Theory methods, the author states: "However, game theory has not yielded a single model to explain oligopoly." (p. 228) Oligopoly and Banking Banks offer almost generic products to their customers and there remains a very thin chance that the competition within the industry is driven by prices. Since pricing of loans of corporate nature are linked with some benchmark rates like LIBOR or any money market rate therefore pricing most of the times do not serve as a better indicator of the competition in the industry. For the purpose of defining research objects for assessing the market structure of the Banking sector, most of the studies have divided the Banking markets into consumer as well as corporate banking markets. (Berg and Kim) . Based on these criteria, it is established that Banks have the Oligopolistic dominance in the consumer markets as most of the banks remain in the position to dictate price to the consumers. (Berg and Kim). Corporate Banking as well as retail deposit collection largely therefore depends upon the level of services offered by the banks to these clients and as such a non-price competition emerge within this niche of the banking market suggesting a mixed nature of the market with some banks have predictive power of price determination in consumer segment while other follow. An orthodox point of view regarding the banking competition was largely of the protectionist in nature as most of the central banks avoided the competition in the Banking sector to avoid the serious repercussions of bank runs however this view is sharply being contrasted as new research and studies are emerging. (Pueyo). Besides an indication of the Central Bank for a monetary policy, for instance, can lead to a chain of interest rate tramps by the individual market individuals. If such strategic decisions, particularly among major individuals, tend to become responsive in the sense that an initial tramp by one player leads to tramps by others and, the process follows until the market equilibrium is reached or the Central bank intervenes; then it would be easy to conclude that banking products are under an oligopolistic nature. (Fisher and Hempell). Though it is largely considered as a fact that the competition within the oligopoly is more of a price driven but due to the different and typical nature of the banking industry offering mostly generic products seems to offer a challenge to the banking companies to look for non-price based competitive criterion. As described above that the banks do tend to have some price dominance in the domain of retail banking however competition in the corporate banking segment largely depends upon how effectively the relationship banking has been strong with the customers. With the increasing trend of financially aware consumers, Banks now are concentrating on the marketing as a supportive tool to strengthen their position in the market. (Durkin and Howcroft). This non-price competition often take the form of promotional activities like offering extended periods of credit without interest on credit cards, preapproved overdraft facilities, priority banking etc. Though there seems to be an oligopoly in the financial markets however there are various factors which actually influence the decision making of the oligopolistic players in the market. These include non-pricing transactions such as information asymmetry, moral hazards, political perks, preferred access to the markets etc. (Choudhury). These influencing factors also tend to reshape the markets in the new dimension where the markets are largely viewed as social contracts. Oligopoly and Banking Sector in Spain Historically, banking sector in Spain has evolved in the context of the perfect collusion and state capture. (Pueyo). Current historiography accounts for the performance of Spanish Banking firms in terms of "monopoly" and State capture. Banks or, at least, the largest ones would have worked in co-operation to restrain competition in financial markets and dictate the rules of behaviour to the whole financial agents. Additionally, they could rely on government support because regulation would have been designed to enforce collusive agreements. Therefore, Spanish Banking industry has historically remained under the influence of government as well as collusion between the large banks supposedly due to potential threats of bank runs as well as avoiding unnecessary competition under the flagship of protectionist government policies. Tight regulation prevailing before the wave of liberalisation of the last decades of the twentieth century has been interpreted as a lack of rivalry among banks either because competition was forbidden by law or because private entities successfully enforced collusion with government support. Spanish historiography supported this type of argument to characterise the Spanish Banking industry. Particularly, in Spain this reasoning has political origins, because it was devised by one of the political groups within the Franco regime to be used against its rivals. Some years later, it was developed by the leftist opposition to criticise the adherence of economic oligarchies to Franco governments. However, the analysis had some empirical support, although it was not developed in a systematic way. High concentration, lack of entries in the industry, and close connections among banks through interlocking directorates generated sufficient conditions to be interpreted as a collusive Oligopoly, according to the contemporary theories in Industrial Organisation. Recent studies also suggest that there exists empirical evidence where collusive agreements were signed between the various top banks especially in the regime of Franco with clauses about maximum deposit rates, minimum loan rates, fees, enforcement bodies and fines. (Pueyo). Spanish Banking Sector like international banking scenario is facing the strong pressures in reducing the margins especially in the wake of relatively higher degree of liberalization as compared to past. All of the empirical studies which has been done in the past took into account the analysis of cost and margins in order to judge the relative degree of competitiveness in the banking sector of Spain however they remained inconclusive as to whether the degree of competition within the banking sector of Spain has changed over time or not. (Maudos, Pastor and Perez). In order to tackle this situation, as I have discussed above, banks in the Spain has started to initiate non-price form of competition by bringing in specialization in order to increase the efficiency and lowering average costs besides concentrating their focus on gaining strategic advantages on the basis of non price competition. (Maudos, Pastor and Perez). However, Spanish Banking sector in the last two decades of the 20th Century do have witnessed a strong form of price competition resulting into drastic reductions in the margins as well as thin bottom lines of the profit and loss accounts of the banks besides exposing their efficiency levels and loose bargaining position. Moreover, 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). However, it does provide banks, the necessary strategic advantage through which they can create an edge over their competitors thus attaining the price leadership status and in this way create ancillary strengths to create competition in the industry. The first attempts for globalized markets are made by those that are fit enough to make such attempts; in this case, there is a concentration in the gaining of global markets on a few big national players, hence an oligopolistic domestic market is the most probable conclusion. Guillén & Tschoegl (1999) present very persuasive evidence in this respect with Spanish banks operating in Latin America, as an example from the text to provide evidence: “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). Potentially two groups dominate the Spanish Banking industry.i.e. Santander Central Hispano (SCH) and Banco Bilbao Vizcaya Argentaria (BBVA), accounting for approximately 40 percent of the sector’s total assets.  These groups are followed by the savings banks La Caixa and Caja Madrid, while Banco Popular ranks fifth. Despite that, traditionally, Spanish Banking sector has remained under the dominance of Big Seven Banks. The “Big Seven” were the seven largest Banks: Banco Español de Crédito, commonly known as Banesto; Banco Central; Banco de Bilbao; Banco Popular Español; Banco de Santander; Banco de Vizcaya; and Banco Hispano Americano.  These banks had direct or indirect control of approximately 80 percent of the countrys banking resources and were present in almost every area of finance.  They also controlled the country’s largest industrial portfolios and had extensive retail networks spread throughout the entire country. (Crowley). Governments of Spain also helped created the new and bigger financial institutions through merger and acquisitions potentially aimed at competing with other European Banks. This act however proved in culminating the market powers of the resulting financial industry giants thus helping the industry to hark itself into the domain of Oligopoly. (Crowley). In the earlier years of this decade, two large groups, Santander Central Hispano Group (SCH) and Banco Bilbao Vizcaya Argentaria (BBVA), have the dominance over the sector.  Together, they account for more than 30 percent of the loan market, 40 percent of the sector’s total assets and 40 percent of the mutual-fund market in Spains private banking sector.  SCHs assets exceed $350 billion, while BBVAs are in the $280 billion range.  They each have market capitalization in excess of $40 billion, putting them just behind Deutsche Bank. (Crowley). Apart from the above market strength, these seven top banks are also being protected through mushrooming of their branches all across the country thus making it extremely difficult for the foreign banks as well as new entrants’ entry into the market. Traditionally, banks working under oligopoly base the strength of competition within the industry on the basis of rates offered in deposits and loans besides competing on the number of branches. (Valverde). During the period of 1980’s, the Spanish Banking sector witnessed an intense price based competition between the saving banks as well as commercial banks. Since the aim was to increase the market shares therefore both these groups engaged themselves into aggressive pricing strategies with potentially no leader seems to be emerging having such dominating powers to dictate the price in the market. (Valverde) However it was the later era which due to liberalization of the financial sector which gave various banking groups enough market power to dictate the price based competition The recent turmoil in emerging markets reduced the banks’ valuations but this reflects judgments about the markets and not necessarily about the banks’ activities”. Besides this, literature supports to a greater extent the oligopolistic internationalization of the Spanish banking industry, for example, the 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). Thus, this facts and figures pointed as evidence show the cartelization and presence of oligopolistic control amongst the Spanish banking system. Increased internationalisation thus gives banking companies more dominance in their domestic markets especially if the international operations are profitable besides offering an opportunity to transfer the technology to the domestic markets to improve upon the competition besides oligopolistic model of foreign direct investment suggest that the efficiency of multinational banks improve by the possession of entrepreneurial resources and skills developed initially in the national market, which could be applied in foreign markets at a very low marginal cost. Oligopoly models also conceive the multinationalisation and geographical diversification of banks as a defensive action against changes in the environment in which they operate. (Sanchez-Peinado) Conclusion Looking at the evidence presented both from the historiography and the econometric studies, it can be concluded that there have been convincing circumstances that have led to massive revenue earning business towards a few banking players; earnings that helped them consolidate their position in terms of size and profitability. On times of deregulation of the banking industry, the major players have tended to cooperate with each other in attempt to prevent crisis; however, the market strategies have implied that the collusive arrangements were diversified with events of variation, called cheating in oligopoly language, where individual members tried to perform better than others by taking advantageous decisions. It is unimportant if others followed these decisions sooner or later. However concentration levels, profitability and efficiency levels have tended to move within a narrow range and, several studies have been assembled which support an H statistic (Annexure I) that does not proclaim an outright oligopolistic market for Spanish banks. Moreover, Rozas (2007) comments, “An alternative explanation would consider instead that large banks are closer to long-run equilibrium than smaller banks, which presumably embrace new arrives [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”. Thus, the Spanish banking system is not considered to operate under a strict oligopolistic situation, although, some literature sources named in this essay suggest that the Spanish banking system operates under an oligopolistic manner. Bibliography 1. Berg, Sigborn Atle and Moshe Kim. Banks as multipleoutput oligopolies: An empirical evaluation of the retail and corporate banking markets. Research Report. Oslo: Norges Bank, 1994. 2. Choudhury, Masudul Alam. "Markets as a system of social contracts." International Journal of Social Economic 23.1 (1996): 17-36. 3. Claaessens, Stijn and Luc Laeven. "What Drives Banking Competition? Some International Evidence." Journel of Money, Credit and Banking 36.3 (2004): 563-583. 4. Crowley, Helen. "International Market Research: Financial Services in Spain." 07 02 2004. Industry Canada. 22 Jan 2008 . 5. de., Rozas Luis Gutiérrez. (n.d.). 6. Durkin, Mark G. and Barry Howcroft. "Relationship marketing in the banking sector: the impact of new technologies." Marketing Intelligence & Planning 21.1 (2003): 61-71. 7. Fisher, Karl Hermann and Hannah Sabine Hempell. "Oligopoly and Conduct in Banking: An empirical analysis." 26 April 2005. 21 Jan 2008 . 8. Gunther, Richard. "Book Review on " Banking on Privilege: The Politics of Spanish Financial Reform." The American Political Science Review (2000): 750-752. 9. Maudos, Joaqun, Jose M Pastor and Francisco Perez. "Competition and e ciency in the Spanish banking sector: the importance of efficiency." Applied Financial Economics 12 (2002): 505-516. 10. Pueyo, Javier. "Collusion, Regulation and Rivalry in Spanish Banking during Franco Regime." 2007. 11. Sanchez-Peinado, Esther. "Internationalisation process of Spanish banks: strategic orientation after the mergers." European Business Review 15.4 (2003): 245-261. 12. Shubik, Martin. "Oligopoly Theory, Information and Communication." The American Economic Review (1975): 280-283. 13. Swann, Michael and William A McEacher. Microeconomics- A Contemporary Introduction. Victoria: Nelson- Thomson Learning, 2001. 14. Valverde, Santiago Carbo. "Estimating the intensity of price and non price competition in banking - an application to the Spanish Case." 2005. Fundacion BBVA. 22 Jan 2008 .  Annexure 1 Read More