Экономические науки/Финансы

Madina Tuleshova

University of International Business

Development of banking competition in the modern world

The global financial crisis reignited the interest of policy makers and academics in bank competition and the role of the state in competition policies (that is, policies and laws that affect the extent to which banks compete).  Some believe that increases in competition and financial innovation in markets such as subprime lending contributed to the financial turmoil. Others worry that the crisis and government support of the largest banks increased banking concentration, reducing competition and access to finance, and potentially contributing to future instability as a result of moral hazard problems associated with too-big-to-fail institutions.

As in other industries, competition in the banking system is desirable for efficiency and maximization of social welfare. However, due to its roles and functions, there are some properties that distinguish it from other industries. It is important to not only make sure that banking sector is competitive and efficient, but also stable.

There are several approaches to measuring bank competition. These include decomposition of interest spreads, measures of bank concentration under the so-called “structure-conduct-performance” paradigm, regulatory indicators that measure the contestability of the banking sector, and direct measures of bank pricing behavior or market power based on the “new empirical industrial organization” literature.

An approach used by some studies to analyze bank competition is based on interest spread decomposition. But spreads are outcome measures of efficiency, and in addition to the competition environment, cross-country differences in spreads can reflect macroeconomic performance, the extent of taxation of financial intermediation, the quality of the contractual and judicial environment, and bank-specific factors such as scale and risk preferences. So these effects need to be controlled for before analysis competition.

The so-called structure-conduct-performance paradigm assumes that there is a stable, causal relationship between the structure of the banking industry, firm conduct, and performance. It suggests that fewer and larger firms are more likely to engage in anticompetitive behavior. In this framework, competition is negatively related to measures of concentration, such as the share of assets held by the top three or five largest banks and the Herfindahl index.

According to this approach, banking concentration can be approximated by the concentration ratio—the share of assets held by the k largest banks (typically three or five) in a given economy—or the Herfindahl-Hirschman index (HHI), the sum of the squared market share of each bank in the system. The HHI accounts for the market share of all banks in the system and assigns a larger weight to the biggest banks. Instead, concentration ratios completely ignore the smaller banks in the system. The concentration ratio varies between nearly 0 and 100. The HHI has values up to 10,000. If there is only a single bank that has 100 percent of the market share, the HHI would be 10,000. If there were a large number of market participants with each bank having a market share of almost 0 percent, the HHI would be close to zero.

However, concentration measures are generally not good predictors of competition.  The predictive accuracy of concentration measures on banking competition is challenged by the concept of market contestability. The behavior of banks in contestable markets is determined by threat of entry and exit. Banks are pressured to behave competitively in an industry with low entry restrictions on new banks and easy exit conditions for unprofitable institutions—even if the market is concentrated.

Therefore, instead of using concentration, much of the recent research on the subject focused on direct measures of bank pricing behavior or market power based on the “new empirical industrial organization” literature.  These include the Panzar-Rosse H-statistic, the Lerner index, and the so-called Boone indicator.

The H-statistic captures the elasticity of bank interest revenues to input prices. The H-statistic is calculated in two steps. First, running a regression of the log of gross total revenues (or the log of interest revenues) on log measures of banks’ input prices. Second, adding the estimated coefficients for each input price. Input prices include the price of deposits (commonly measured as the ratio of interest expenses to total deposits), the price of personnel (as captured by the ratio of personnel expenses to assets), and the price of equipment and fixed capital (approximated by the ratio of other operating and administrative expenses to total assets).

Higher values of the H-statistic are associated with more competitive banking systems. Under a monopoly, an increase in input prices results in a rise in marginal costs, a fall in output, and a decline in revenues (because the demand curve is downward sloping), leading to an H-statistic less than or equal to 0. Under perfect competition, an increase in input prices raises both marginal costs and total revenues by the same amount (since the demand curve is perfectly elastic); hence, the H-statistic will equal 1.
Another frequently used measure is based on markups in banking. The indicator, so-called Lerner index, is defined as the difference between output prices and marginal costs (relative to prices). Prices are calculated as total bank revenue over assets, whereas marginal costs are obtained from an estimated translog cost function with respect to output. Higher values of the Lerner index signal less bank competition.

Finally, the Boone indicator is a recent addition to this family of indices. It measures the effect of efficiency on performance in terms of profits. It is calculated as the elasticity of profits to marginal costs. To calculate this elasticity, the log of a measure of profits (such as return on assets) is regressed against a log measure of marginal costs. The elasticity is captured by the coefficient on log marginal costs, which are typically calculated from the first derivative of a translog cost function. The main idea of the Boone indicator is that more-efficient banks achieve higher profits. The more negative the Boone indicator is, the higher the level of competition is in the market, because the effect of reallocation is stronger.

Did competition cause the big financial crisis?The basic observation that competition increased before the crisis does not necessarily suggest that greater competition in itself spurred the crisis. Recent studies suggest the problem was in other things, in particular in missing incentives for adequate risk management missing, and in lax supervision.  In fact, the run-up to the crisis was characterized by an increase in market power (Anginer, Demirgüç-Kunt, and Zhu, 2012).

The financial crisis—and the subsequent policy responses by governments—may have affected the competitive conduct of financial intermediaries in industrial countries.  Bank competition in developed countries deteriorated during this period, especially in countries that had large credit and housing booms (such as the United States and Spain). This is confirmed by measures such as the Lerner index and the Boone indicator.

The Kazakhstan banking system in process of the development and formation repeatedly felt the crisis shocks caused from the one side by specific features of the domestic bank sphere, and from the other side by general difficulties and shortcomings, inherent in banks in the different countries.  Nowadays the process of integration of the whole Kazakhstan economy and particularly banking system into the world economy and respectively into the world financial system is proceeds.  This tendency means that crisis factors typical for banking systems of any country are more influence for the Kazakhstan banks.  The modern economic situation demands the search of the new directions in increasing the efficiency of crisis management in the bank sphere, in the analysis of the reasons and the factors constraining its development.

Due to January 1, 2012 the banking sector of Kazakhstan is presented by 38 second level banks.  Since the beginning of the year, assets of the second level banks are increased by 786,4 billion tenge or by 6,5%.  The bank loans granted by other banks, also loans and the financial leasing, provided to the organizations which are carrying out separate types of bank operations, contained 85,6 million tenge, thereby having decreased by 10,9 million tenge.

It should be noted, that at the beginning of 2012 year JSC “Fund of Kazakhstan’s Problem Credits” was created, with which it was planned to improve the quality of assets of banks, and also to help SLB(Second Level Banks) to get rid of bad debts. The main objectives of the Fund are repayment of stressful assets from banks, the subsequent management and then sale of assets. As a result the net profit of banks following the results of 2012 consisted 34 billion tenge. The banking sector of Kazakhstan is showed the biggest profit in 2007 of 0,22 trillion tenge, which is the most maximum gain on all indicators for the considered period. However in a sufficiently short period of time during 2008, the decrease in indicators of profitability are happened more than 20 times to 0,01 trillion tenge which was caused mainly by influence of financial crisis.

Table 1

Dynamics of Kazakhstan banking sector indicators, billion tenge.

Financial index	2007 y.	2008 y.	2009 y.	2010 y.	2011 y.
Assets	11 685	11 890	11 557	12 032	12 818
Obligations	10 260	10 437	12 537	10 715	11 515
Owncapital	1 425	1 453	- 980	1 316	1 303
Retained profit for the current year	217	11	-2 834	1 420	34
Credits	8 868	9 238	9 639	9 065	10 473
Deposits	6 424	6 873	7 799	6 851	7 797
ROA, %	1.90	0.09	-24.52	11.80	0.27
ROE, %	15.23	0.76	289.18	107.90	2. 61

Despite to the presence of foreign banks, the banking sector of Kazakhstan is differs by a high degree of concentration. Five large banks with 65,3% of all market are dominate.

The loan portfolio of banks is increased by 5% since the beginning of 2008, but was reduced by 9% since July, 2009. Large banks of Kazakhstan are carry out the process of restructurisation of the loan portfolios – prolongation of terms, revision of rates. They accumulate liquidity by the process of it, but don't direct it on new crediting, and conduct conservative credit policy. By reduction of a loan portfolio the share of liquid assets on balance is increases and, respectively interest income and percentage of margin is decreases. Liquidity is collects for a possible covering for further losses and provision formation.

The main problem is still a large volume of problem credits in the construction and corporate sectors.  The problem credits are remain at a high level (more than 37% of a credit portfolio of the banking system).

Today it is possible to note that the situation in the banking sector is reasonably operated, and in most cases is given into the correction from regulators of Kazakhstan. Therefore, the world financial crisis appeared as a peculiar check of stability of a national financial system of Kazakhstan.

At the same time the experience developed in the country, shows that there is no time for relax and it is necessary to undertake the preventive measures, capable to protect the financial system of the country from now on. One of such measures is crisis management in the bank sphere.

The need of stability maintenance of the domestic banking system is explained by its important role in economic system of the country. For years of independence domestic banks are created the developed financial system which has become the integral component of domestic economic system, providing their functionality and stimulating their development on market conditions. The anti-recessionary regulation of the state is a system of organizational, economic and legal measures and actions of the state directed on prevention of bankruptcy of the credit organizations and achievement of stability in the bank sphere.

The base of the state anti-recessionary regulation includes: the situation analysis, setting goals, development of the tools capable to transform crisis situations in the direction of the solution of objectives. The state anti-recessionary regulation is directed on achievement of the following purposes:

1.  Strengthening of supervision system and regulation of bank activity;

2.  Introduction of the counterrecurrence principle in regulation of the banking sector;

3.  Improvement of regulation procedures and supervision of the financial market and financial organizations;

Achievement of goals demands the execution by the state of the two most important functions – preventive and protective. Preventive function is directed on minimization of risk activity of the state. By this function the state is reduces the potential possibility of bank crashes and by that is prevents the crisis of the whole banking system.  The main goal is restriction of the bank operations bearing a high risk.  Realization of this function is carried out by development and adoption of normative legal acts.  Protective function of the state is urged to guarantee interests of investors in case of bankruptcy of bank and to provide financial support of concrete bank in case of its crisis state, given by National bank as a creditor of final instance. Thus, the state anti-recessionary regulation of the bank sphere doesn't set the task to prevent bankruptcy of each separate bank. It has macroeconomic character and has to be aimed at protection of the system interest. 

Based on lessons of present crisis, the world financial community notes that the process of regulation toughening and subjects supervision of financial sector is needs to be supported with strengthening of macroprudential approach for prevention of system risks. The macroprudential policy pays the main attention to risks of the financial system as a whole. Such risks can be multisectoral, mention many organizations and the markets, or can be concentrated in several key sites of system. Macroprudential approach has to add and strengthen existing structure of regulation and supervision in which the main attention is given to reliability of separate institutes and the markets.

One of the directions of strengthening of supervision system and regulation of the banking sector is regulation of the level of competition in the financial market. The Kazakhstan financial system is characterized by reasonably high level of market concentration. As it was already noted, it concerns the banking sectors of the country. To increase the efficiency and stability of the domestic banking system one of the key priorities of anti-recessionary regulation will be restriction of level of concentration and competition stimulation in the banking system of the country. It provides need of gradual increase in the minimum size of the capital of banks as a direct measure. Integration and consolidation or their reorganization in other types of financial institutions will promote growth of number of the average banks capable on mass products to render due to competition to large banks. Finally these tendencies will promote as a whole to depreciation of banking services, protection of interests of clients, ensuring bigger stability of the banking sector, decrease in susceptibility of economy of Kazakhstan to system risks of large banks. Moreover, the world experience of the banking sector development showed that the most successful condition of bank development and banking products is their competitiveness, and also low concentration of the capital. It is also important from a position of expansion to coverage and access of the population to the widest list of banking services, in particular, in regions, increases of the competition and a level of provided services quality. Therefore, one of the main objectives of the post-crisis period is need of elimination of the revealed problems of financial sector, correction of the made mistakes and the direction of its development in line with stable forward growth.