Research Report: Competition Level and Efficiency in Australian Banks

This report investigates the level of competition within the Australian banking sector, focusing on the factors that influence it and the methods used to assess its impact. The research aims to identify the efficiency levels in Australian banks and the role of performance variables, as well as the relationship between competition and bank efficiency. Utilizing a sample of five Australian banks from 2005 to 2015, the study employs the Lerner index model, which uses price elasticity of demand to measure market power. The introduction highlights the rise in banking competition due to global financial crises, the impact of government support, and the importance of maintaining financial stability for economic growth. The literature review explores various measures of competition, including structural and non-structural models, and examines the effects of deregulation, foreign bank entry, and inflation on competition levels. The analysis considers the Rosse-Panzar model, the Lerner Index model, and the panel vector error correction model to provide a comprehensive understanding of the dynamics within the Australian banking industry.

Accounting research

Abstract
The main purpose of study is to identify level of competition in banking sector and what
are the factors that have resulted in it. Also, there are different methods used by researcher to
identify factors due to banking competition is affected. The main objective of study is to identify
the level of efficiency in banking sector of Australia and role of performance variable in it.
Moreover, another objective is to identify relationship between competition level and efficiency
of bank. The country selected for research is Australia and sample of 5 banks have been taken.
Moreover, data is gathered from year 2005- 2015. The method that is chosen is leaner index
model because it uses price elasticity of demand to measure market power. So, with help of this
it has been determined that how rise in demand of financial services changes price.

TABLE OF CONTENTS
INTRODUCTION...........................................................................................................................1
LITERATURE REVIEW................................................................................................................1
CONCLUSION................................................................................................................................7
REFERENCES................................................................................................................................8

INTRODUCTION
In present times due to financial crises at global level there has been high rise in banking
competition. This has resulted in change in policies and rules related to finance. It is difficult for
banks to compete at global level. Global crises have highly affected the financial stability of
banks in developing countries. Moreover, government support results in reduction in
competition. It is analysed that instability in financial sector is due to competition among banks.
But on other hand competition benefits social welfare. Centralised banking system has increased
market power which has allowed bank to charge high interest rate. It is essential to maintain
stability in financial sector so that economic growth is preserved. Banks performance is
differentiated on basis of certain factors that include roles and responsibility assigned by
government as well.
Moreover, competition in banking highly impacts on growth and development of
companies. The overall banking sector is divided into many elements such as liberalization,
regulation, financial innovation, merger and acquisition, etc. These all are integrated together in
order to access the competition in banking sector. Government plays a vital role in maintaining
stability and competition in banking sector. Their intervention and regulation enables in solving
issues and measuring banks performance. However, reforms and policies formed supports in
setting structure of banks. Besides this, it helps in controlling monopoly of banks. Alongside it,
higher monopoly banks are having close relationship with companies. They are more flexible in
allocating funds.
There are various measures available through which banking competition is measured.
Here, lerner index approach will be used to measure degree of competition. It determines the
ratio of difference between price and marginal cost. The lerner index describe relationship
between price margin and elasticity of firm. In this index range is 1 to 0. So, having high index
refers to greater market power. Besides this, if firm lerner index (L) is 0 there is no market
power. However, marginal cost is 0 , it indicates monopoly power. Besides this, lerner index
analyses market power separate from loans and deposit markets.
LITERATURE REVIEW
In recent times, it is been observed that in banking the competition has increased to great
extent. This is because of many factors which have affected different country banking industry in
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different way. Due to this their economic growth is impacted as well. In this section there are
two parts in which one describes different measures of competition used by author to conduct
study and second is theoretical framework that discusses view points of author.
Measures of competition
() stated that there are usually two ways of measuring competition that is categorised in
two ways that is structural and non structural ways. The structural model was developed by Bain
and is called structure conduct performance paradigm. It represents whether there is relationship
between structural feature of industry with firm or not. It states that if there are no entry and exist
barriers in industry the competition will be high. Industry structure shows consists of many
variables like number of buyers, sellers, technology, etc. it this model it is assumed that there is
informal relationship between structure of bank and their performance.
Structure and conduct performance paradigm [SCP]
According to Rakesh Arrawatia Agartal and Dr. Arun Misra (2003) shows that Structure
Conduct and Performance [SCP] paradigm conveys that economic performance of banking
industry is a function of the conduct of buyers and sellers. There have been several changes that
have occurred in banking sector. In this issue identified by author is that the entering of foreign
banks into other countries has resulted in bank consolidation. With this there has been rise in
banking competition. It has effected by reducing choice of user on availability of credit and other
banking services. Also, it has impacted on distribution of loan between different sectors in
economy. Alongside it, foreign penetration in banking has made competition intense. It has been
analysed that competition remain high when ratio of foreign owned banks is high as compared to
government ones. In this the impact is in economic terms as compared to sustainability. But on
other hand, there is positive impact in competition level as well. It has been concluded that
competition in banking sector highly impacts on quality of services and innovation. Apart from
it, there is negative relation of inflation rate on competition. It is because rise in inflation rate
does not impact on competition
Rosse -Panzer model
In the view of Laurent Weill (2012) banking competition is measured by Rosse-Panzar
model and efficiency is estimated with stochastic frontier approach. Here, the issue identified is
that there has been change in situations which slows down growth of profit when there is
increase in asset and size of bank. Furthermore, when bank size is measured by asset and pre tax
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profits their profit growth decreases. The evolution of liberalisation has also impacted on
banking competition. It has allowed countries and government to enable foreign banks to enter
and operate within nation. Due to this economy of scale has increased. There have been major
changes in policies and procedures of providing financial services. Also, it has resulted in
redefining tax rates and financial regulations. Now, many banks are participating in offering
services in other countries. Thus, it has deregulated the economy of nation. Along with it, nation
financial stability has also improved. It can be concluded that the degree of competition refers to
the extent that how banks are able to generate profits. But in recent times the degree of
competition in is getting more intense. Many banks have emerged in different countries due to
which there is change in structural and regulatory index.
Lerner Index model
As elucidated by Phillp Davis (2018), his research question was whether there exits
relationship between bank competition and risk trade off. For this lerner index was used. Also,
banks provide a framework which identify flow of currency within nation, allocation of
resources, etc. it also supports in fostering growth of nation. Besides this, companies depend on
bank for getting financial support. Moreover, the entire nation financial performance depends on
bank. However, government possess more power and control over banks. An overall structure,
policies, etc. are developed to regulate banking sector. In times of crises banks are the most
suitable source of capital for companies. If there comes a situation of crises than banks are
having ability to handle it. So, it is concluded that if policies, structure, etc. are modified it
directly impacts on overall competition in banking industry. Hence, the financial performance of
banks is also impacted. This hampers nation economic growth as well.
Panel vector error correction model
According to Manju Jaykumar (2015) a question was asked that whether banking
competition impacts banking stability or not. For this panel vector auto regressive model was
used. It can be said that competition does not only show stability but also include efficiency in
services, quality and innovation. It also depends on power of market which defines ability of
bank to generate profits by rising price of good or service (Competition in Banking Industry.
2012). It helps in economic growth of nation. Basically, a nation GDP depends on overall
performance of banking sector. So, having a proper stability leads to effective economic growth
of nation. Furthermore, it is stated that there are several factors which impact on stability of
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banks. The factors may be either internal or external. It is summarised that it is necessary to
identify factors so that its impact can be mitigated. This is done by making change in interest
rate, structure, policies, etc. which helps in developing strategies and taking appropriate
measures. From study it is analysed that both banking competition and stability are key drivers in
long term economic growth of European countries. This enables them to maintain economic
sustainability performance of country.
Two period model
As said by Elena Carletti, (2007), deregulation has resulted in rise in competition. The
main issue due to which banking competition is affected is due to deregulation. In this study two
period model was used. In 1980's many countries liberalized and deregulated their banking
sector. This was done to improve performance of banks and develop a centralised banking
system. Also, it allowed developing countries to implement this concept to boost their growth.
An example can be taken of India where seven private banks were been nationalised by
government. This was done to reduce issues that were identified by Narasimham Committee.
This process highly benefited in forming policies and specific structure. The government was
having monopoly to regulate activities of bank. This suggestion was helpful for other developing
countries. They also started centralising their banks in order by deregulation. Furthermore, it was
supported in maintaining stability in market.
Theoretical considerations
In opinion of Marie-Odile (1997), research question was analysis of competition in the
credit market yields the competitive outcome. In this assumptions were made. There have been
many changes in policies and regulations done which have influenced banking competition. The
changes have occurred both in developed and developing countries. Also, market power leads to
social inefficiencies that translate into a loss of social welfare and thus a need to measure and
improve competition in banking system. When there is high inflation and interest rates, there was
higher market power and thus lower competition. When there is an increase in competition, it
benefits stability to some extent but after reaching certain level, it increases risk taking activities
and breaks the balance of risk return trade off due to competitive pressures, making banks more
vulnerable to failure.
Bandaranayake, Das & Reed, 2018 has also used the same model that is RossePanzar
model. He said that deregulation in financial sector have allowed big and private banks to
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regulate overall banking sector. The less intervention has allowed banks to monitor and control
financial sector by formulating policies and procedures. Besides this, there is shift in market
condition due to deregulation of bank. It has been analysed that dominating power of foreign
bank have shifted market from low to high competition. It shows that domestic market banking
system gets more effective and there is reduction in interest margin.
According to Rakesh and Dr. Arun 2012 in developed countries banking competition is
measured to an extent in which banks are able to deal with inflation. In those countries there is
less intervention of government in regulation. They allow foreign banks to enter and improve
financial stability. This is the reason due to which currency rate is high and maintained. Along
with this, high rise in banking competition can result in ineffective financial stability. This is
because when competition is high profits growth margin decreases. It also restricts banks to
allocate loan amount. Also, it reduces capability of bank to expand. Moreover, there occurs
difference between loan allocations in different sector. The bank might be able to allocate funds
more in those areas where there is high growth in profits. It also reduces asset value of bank and
efficiency of providing shirt term loan. This forces business as well as people to withdraw their
money from bank if asset value is lower than its liquidation value. Bank runs result from either
(both) a coordination failure among depositors or an expectation of poor performance of the
bank. Runs may be costly, because they force the interruption of a production process and the
premature liquidation of assets. Moreover, runs may trigger a systemic crisis, if they propagate
through the economy.
On contrary Yanelle, 1997 stated that in some developing countries enter of foreign bank
has improved the financial stability of nation. This can be illustrated by giving example of
Philippines where foreign bank improved their stability. This was a great turnaround in their
financial stability. It helped in promoting financial services and rising value of asset.
According to Degl’Innocenti, 2015 financial sector growth is fast as compared to other
countries where competition is higher. Thus, banking stability increases industrial growth. But it
has been analysed that rise in interest rate by competing bank can hamper non financial sector.
However, banks with more competitiveness are able to provide more loans to business. The main
aim is to foster economic growth. Also, it is observed that lack of competition leads to high
interest rate which results in low availability of credit. Due to this, banks are not able to boost
economic growth of nation. Its negative affect is there is rise in prices of financial services.
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In view of Manju, 2015, increase in degree of competition decreases industry growth, this
situation occurs during non crises period. Whereas, industry with external financial dependence
have better performance. Every sector is having a relationship with banks. This states that having
a strong relation leading towards economic growth. It includes utilisation of funds, setting
pricing policies, cooperation, etc. in addition to it, relationship between structure and industry is
derived from micro economic model of perfect competition markets.
As critiqued by Pruteanu-Podpiera, Weill & Schobert, (2016) there is strong relationship
between competition policies and policies of banking stability. It is because any change in one of
them automatically influences other. But it may not be confirmed that further changes in policy
makes leads to taking successful measures. Usually, banking competition refers to relation
between financial services and creation of such services for consumers a well which influences
market. It also describe how well nation financial stability is been maintained by bank and how it
contributes in GDP of nation
As elucidated by Bianchi & Mendoza (2018) banking competition can have diverse affect
on inflation rate as well. This is because during times of inflation there banks have to maintain
financial stability. This is done by either increasing loan amount or reducing repo rate so that
financial stability is maintained. Moreover, when banks are subject only to liquidity shocks, the
economy shows multiple equilibria. Either depositor do not run and the payment system is
efficient in reducing the opportunity costs of holding liquid assets; or depositors run and banks
have to liquidate the long-term assets.
Also, Jeffrey 2018 stated it has been observed that deregulation in banking sector has
affecting competition as well. It is because there are several restrictions which is been lifted from
it. So, it has allowed banks to expand their investments and allocate more loans. However, there
is a high degree of instability in banking sector due to deregulation. Also, due to banking
competition there is impact on market structure as well. Generally, with entry of bank market
share rises. There is change in inflow and outflow of cash within the nation. Besides this, most of
times foreign bank merge with domestic one to identify market situation. It is useful in analysing
recent financial stability and how it can be improved.
On contrary Yanelle. (1997), stated that high competition in banking sector reduced price
of financial services and contributing more in welfare of country. It results in developing a
monopoly market and allowing banks to reduce prices of services. It has been observed that in
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European countries about 30-50 % transition countries in terms of cost inefficiencies. Thus, the
decrease in loan rates and monopoly rents impact on investment and growth in positive way.
Furthermore, it has been observed that in oligopoly market there is less competition which
affects economic growth. In an analysis of Jeffrey (2018) any change in competitive structure
leads to high competition. Thus, large banks are able to operate in more competitive environment
as compare to small ones. In other words it can be said that at national and international level
there is intense competition as compared to local one.
The competition level also depends on what policies and regulations are been formed by
government in order to regulate banking sector. So, any change in policies affects financial
stability as banks directly operate in it. Furthermore, Brain (2018), contradicted that there is no
impact of change in policies but due to entry of foreign banks within nation. Alongside it,
government allows foreign banks to operate in order to improve economic growth. Due to this
there is change in price of financial services. Also, there occurs difference between loan, tax rate,
etc. which directly impact on profits of bank. It deregulates entire financial stability of country
enforcing government to take strict action or measure to monitor competition and improve
performance of large banks. Besides this, when government monitor competition they changes
structure and policies. It also impacts on banking competition.
According to Bert. (2000), rise in inflation rate, instability in currency rate, etc, are not
related to banking competition. This is because there is no relationship between banking
competition and these factors. The change in these factors does not allow to bank to take any
major action. Moreover, global crises have forced government to form integrated policies to
control competition. It is because growth of bank and economic condition are independent on
each other. In many developing countries any change in one of them directly impact the other.
So, it is essential to determine how competition can be controlled and what changes can be made
in policies to do so.
Future research
This research will evaluate factor due to which banking competition is influenced. Also,
there are many measures available through which banking competition is evaluated. It will be
analysed that there exists relation between economic growth and financial stability. If there is
any change in policies and structure of bank it impacts directly on competition. However, when
it comes to regulating price of financial services, the crucial risk factor is change in interest rates,
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government policies, etc. it restricts banks to limit credit giving in order to maintain competition.
Furthermore, a study can be conducted on use of IT in providing financial services and how it
benefits in monitoring activities. Besides this, technology enables in securing transitions between
third parties and customers.
Research questions
The main research questions are as follows :-
 What is level of efficiency in the Australian banking sector and what performance
variables have played role in it?
 Does level of competition in banking sector have a positive relationship or impact on
bank efficiency?
CONCLUSION
It can be summarised that banking competition in Australia is increasing rapidly. There
are many factors behind it such as global crises, inflation rate, etc. also, banking competition and
economic growth are interrelated to each other. Any change in one of them impacts other one.
Besides this, deregulation in banking sector has allowed foreign banks to enter within nation and
affect overall industry. Also, there are various methods which help in measuring competition in
banking sector like SCP, Panel vector error correction model, Rosse -Panzer model, etc. each of
them uses different factors to identify level of competition.
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REFERENCES
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among Financial Service Providers.
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Online
Competition in Banking Industry. 2012. [Online] Available Through:
<https://www.iracst.org/ijcbm/papers/vol1no32012/10vol1no3.pdf>
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