An Evaluation of Competition and Concentration in US Banking Sector

This report analyzes the structure, conduct, and performance (SCP) of the US banking sector, evaluating competition and concentration within the industry. It examines market structure through concentration ratios like the n-firm concentration ratio and the Herfindahl-Hirschman Index (HHI), assessing ...Read More

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Running head: Markets and competition
Structure, Conduct and Performance of US
Banking Sector

Markets and competition
Table of Contents
Introduction......................................................................................................................................3
SCP in US banking sector................................................................................................................5
Structure of the market................................................................................................................5
Conduct of the banks...................................................................................................................6
Performance of the banks............................................................................................................7
Drawbacks to the SCP framework relating US banking sector.......................................................8
Conclusion.......................................................................................................................................9
References......................................................................................................................................10
Bibliography..................................................................................................................................11
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Introduction
The aim of this assignment is to evaluate the competition and concentration in the United State’s
banking sector. This is critically done by analysis of price-concentration relationship in the retail
banking sector of the industry. The assignment will follow along with the lines of Berger and
Hannan (1989), who studied US banking industry in the particular way as well as Okeahalam
(1998), who studied price-concentration relationship in South Africa. The US banking sector
took a new dimension with the initiation of its economic reforms in relation to specific policies
and regulation since the business year 1990. The major strategies applied by the banks under the
competitive business conditions incorporates distinct products and services, strategic marketing
such as advertising, widening customer base by promotional activities as well as diversification
to reduce the risk of operation, mergers and acquisitions in order to consolidate the business and
increase efficiency as well as floating joint ventures with foreign banks for enhancing capital
base and efficient management. The policy and regulatory framework changes brought by the US
government significantly brought huge competition in the market while enhancing the efficiency
of the banks. This significantly raised several issues and affected the structure of the market in
US banking sector. The regulatory roles that have to be made by the banks such as JPMorgan
Chase are to sustain the competitive market and enhance the efficiency of the banks. The
rationale rising behind this issues lies in the structure-conduct-performance (SCP) relationships
developed by Mason (1939), significantly suggests that the possibility of collusive behavior
critically enhances when the market is concentrated with few firms. This, in turn, states that
higher the market concentration, the larger the firm can earn profitability. The SCP relationships
in US banking sector are well explored in the literature. The limitation and contradictions in the
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SCP relationships lie in assumptions relating to measures of market structure. Furthermore, the
market concentration may not be a reflection of the collusive behavior of the banks and it is the
interpretation of their superior efficiency. The consideration of both efficiency and market power
has to be considered for critical understanding and analysis which is largely unexplored in the
existing studies. The assignment has four section discussing SCP relationship in US banking
sector, the structure of the market, and conduct of the banks and performance of the banks in a
detailed manner.
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SCP in US banking sector
Structure of the market
The structure of the market is analyzed in terms of the degree of seller’s concentration as it is an
essential feature of the extent of flawed competition in the US market. As per the industrial
organization literature, the measures used in this study are n-firm concentration ratio and
Herfindahl-Hirschman Index (HHI) in order to learn the extent o market concentration in the US
banking sector. The HHI and n-bank concentration ratio can measure the degree of concentration
in the market entirely. After analyzing the US banking sector, few critiques suggested that the
banks have a stronghold in the market in terms of the banking sector. The supply that affects the
business of US banking sectors is product or service durability and business attitude (Bhatti &
Hussain, 2010). On the other hand, the demands that affect the business are the availability of
substitutes and consumer behavior. The asset base and average market size of the banks
significantly increased during the year 2000 to 2010. There are not many variations in these
measures which state that the asset base and market size are consistent across the US banks. The
diversification and integration of foreign banks in the country significantly affected the market
concentration of US banking sector which affected the business profitability (Jaw, Lo & Lin,
2010). The average market share of the banks was consistently low during the period under
consideration. Although when the extent of variations declined, the market share enhanced. The
entry and exit condition associated with the US banking sector is critical and firm which
critically affects the cost structures and product differentiation. The barriers to entry are at higher
level affecting business profitability. The n-firm concentration ratio and HHI suggest that the
market concentration in the sector is consistently low which in turn decreases market
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concentration during the period. In contrast, the declines have not been critical. Table 1, 2 and 3
in Appendix significantly provides critical explanation of the structure of the market in US
banking sector. After analysis, it has been learned that US banking sector measured in terms of a
market share depends critically on its structural aspect of the market such as past financial
performance and conduct like selling effort (Kunc & Morecroft, 2010). The SCP relationships in
US banking sector is multidirectional as the structure of the armlets impacts performance by
conduct. The relationship is instantaneous as if the selling efforts lagged the financial
performance also lags behind which critically affect the supply and demand of the banks relevant
to cost structure.
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Conduct of the banks
Under the imperfect competition in the market of US banking sector, financial performance of
the banks relies upon to a large extent on its selling efforts which incorporates ‘marketing and
advertising of products’ and services and ‘R&D of service networks’. Advertising
significantly impacts the financial performance of the banks by providing distinct features of its
products and services offered by its competitors creating enhancing image and entry barriers.
Attaining the customers in favour of these distinct features of its products or services critically
makes the demand inelastic over other alternatives and this in turn gains the bank to capture the
market entirely. Advertising also creates significant barriers to entry of the new banks as well as
the upward mobility of the small banks (Lennartz, Haffner & Oxley, 2012). The entrants in the
banking sector might consider advertising to enhance their visibility in the market. In contrary,
intensive counter advertising by the existing banks might drain out the images of the entrants
which critically make to capture low share of the market. This in turn limits the competition level
of the banks in the market which in turn enhances the financial performance of the banks. In
terms of R&D of service networks, expenditure by the banks towards building up such
infrastructure and distribution related to the complementary assets enhances the financial
performance of the banks in 2 significant ways. At first this effort raises the competitiveness of
banks by developing service networks which critically facilitates appropriateness of products and
services which in turn enhances efficiency of the banks. And secondly, such asset enhances the
bargaining power of the banks in terms of equity that is linked with the foreign collaborations as
the national banks have wider services network in comparison to the foreign banks (Lukka,
2010). The selling efforts made by the banks towards promotional and development of the
service networks as well as advertising operating in the US is relatively low with the enhanced
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trends over the years. Table 4 illustrates the selling efforts of the banks. This in turn state that US
banks has used advertising and R&D service networks to enhance its position in the market. In
contrary, it is observed that selling efforts varied considerably across the US banks. After
analyzing it has been learned that the estimated coefficients are critically positive and significant.
It is identified that banks that has a larger asset base, standards financial performance at past and
larger market share can make higher selling efforts in relation to advertising and R&D. It has
been also identified that banks with higher market share attain the channel of advertising and
promotion to enhance their position in the market while creating image advantage,
complementary assets, and strategic entry barriers. In contrary (McWilliams & Smart, 1993)
opposed that greater selling efforts of the private banks are influenced at the huge rate by their
business approaches and motives.
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Performance of the banks
There are two wide strands for comprehending the financial performance of a firm which is the
‘profitability’ and ‘revenue growth’. The revenue growth considers the valuation in the stock
market to analyze the financial performance of a firm. This approach is significantly based on the
assumption of the stock market which assesses performance as well as efficiency in relation to
changes in the share prices while controlling for movements in terms of systematic risk and
market in general specifically. In contrary (Nandakumar, Ghobadian & O'Regan, 2010) opposed,
the revenue growth can few times suffer from the issue like overvaluation and undervaluation in
case the share prices involves random valuation errors. Then it can be analyzed that the share
prices may largely influence because if market correction. On the other hand, the profitability
approach assesses the financial performance of banks after the reform period. The ration of profit
before interest and taxes to the total income is termed as profitability. The ratio of PBIT to
capital employees is known as return of capital employed and the ratio of PBIT to the gross fixed
asset is known as returns on assets. The operating efficiency of the US bank in relation to its
current ratio and cost efficiency can be analyzed specifically. It has been analyzed by few
critiques that the financial performance of the banks significantly fluctuated during the period of
2000-2010 and it has been also noted that fluctuations are relatively high ROE which is
illustrated in Table 5. Also, the financial performance of the banks varied critically and the
difference is critically high in terms of ROE. The current ratio was also similar which is
illustrated in Table 6 (Appendix). In terms of the cost efficiency, the US banks have provided
significant signs of enhancement over the years, in contrary in the business year 2006-2007 the
difference was not high and cost efficiency varied consistently. This, in turn, contrasted the
conduct of banks which affected the business critically. Few interesting dynamics have been
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analyzed significantly in relation to the structure of the market of US banking sector regarding
their financial performance and behavior of the bank. In contrary (Olson, Slater & Hult, 2005)
argued, that the dominating structure of the private banks was considerably high in terms of the
public sector banks. However, the average size as well as market size critically enhanced during
that period in terms of private banks. In contrary, as opposed by (Ralston et al. 2015), the
incorporation of several liberal policy measures did not enhance the market concentration in this
sector and resulted in a marginal declination. The conducts of the banks which offered new
competitive strategies such as selling efforts, promotional activities and R&D did not enhance
the financial performance of the banks which degraded the business. This in turn critically raises
significant issues such as the reason behind the failure of policy reforms in the competitive US
banking sector. However, there was a significant growth in the market concentration and
financial performance relevant to the profitability and revenue growth for the US banks. The
business performance and profitability are evident after analysis and it has been learned that the
banks of the US sector critically focused towards revenue growth by their strategies towards
market conduct. The selling effort made via advertising and R&D critically enhances the
business performance of the company resulting profitability and revenue growth.
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Drawbacks to the SCP framework relating US banking sector
The dynamic behavior of sellers and buyers has an intense effect on the US banking market.
This, in turn, makes it harder to establish and predict fixed market structures. Several difficulties
arise while analyzing the paradigm of SCP hypothesis towards US banking sector due to data
shortage, extensions of markets and multiple definitions. Few critiques have also argued that
SCP hypothesis produces irrelevant data in terms of financial performance as analyzing financial
performance is unidirectional in relation to market intensity. The main problem raised while
conducting the study in the banking sector of the US market is it does not have a fixed
boundaries or limitations associated with the given industry. This critically implies regarding
economic policies and recognizes that market power is hugely dangerous and the relation
between the concentration ratios is significantly harmful. Interpreting higher profits in the
concentrated markets as significant evidence in terms of the market power is critical as the
concentration of market may not be a reflection of the collusive behavior of the US banks. It can
reflect in the consequences of superior efficiency (Surroca, Tribó & Waddock, 2010). The exact
knowledge of SCP relationships is still unexplored and has not been researched at a higher level
as it requires consideration of both market efficiency and market power. In general SCP
relationships are unidirectional and it is critical to make the relationship multidirectional and
dynamic framework. However, the study explored the multidirectional relationship of SCP in
context of the banking sector. Without the multidirectional view, the relationship of SCP is no
consensus in the literature as this could critically impact the analysis of financial performance
and efficiency of the US banks. The SCP in traditional form provides only the general
information of market, strategic behavior and performance in the banking sector. Hence,
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modified SCP has to be incorporated in the literature that incorporates market imperfections
arising from uncertainties functioning of the market, transaction costs and information costs into
the basic market conditions, asymmetric information and market that seem to have an important
force on structure of the strategic behaviour of the banks, banking sector, and its performance.
This basic condition critically affects the public policies, market structure and conduct
performance against market failures (Tung, Lin & Wang, 2010). Hence, incorporating modified
SCP relationship was critical in the study; however, with the help of scholarly journals, the study
has been completed successfully. It is evident that there are several drawbacks associated with
the SCP framework while conducting the study on the banking sector of US but traditional SCP
and the assumptions analysed is the major one. However, relevant information and critical
theories acknowledged by several critiques have assisted towards analyzing the market of US
banking sector.
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Conclusion
US banks have significantly enjoyed high profits and market concentration in the early-mid
1990s before the beginning of the crisis. The crisis returns during the time of profitability after
analysis. It is also analyzed that the profits were built on the shaky grounds of selling efforts and
was typically unsustainable in terms of underlying degree of leverage and bank’s assets. Also, it
can be concluded that the profitability enjoyed by the bank did not boost up their capital base and
allowed the current crisis in terms of financial aspect. However, a high and positive relationship
has been significantly found between the concentration and profitability with the incorporation of
individual operational efficiency, market share and market size of the bank. The dependent
variable ROE and ROA have critically in Table 7, 8 and 9 (Appendix) assisted towards the
measures of concentration which critically assisted the SCP hypothesis between overall
concentration and profitability.
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References
Bhatti, G. A., & Hussain, H. (2010). Evidence on structure conduct performance hypothesis in
Pakistani commercial banks. International Journal of Business and Management, 5(9), 174.
Jaw, C., Lo, J. Y., & Lin, Y. H. (2010). The determinants of new service development: Service
characteristics, market orientation, and actualizing innovation effort. Technovation, 30(4), 265-
277.
Kunc, M. H., & Morecroft, J. D. (2010). Managerial decision making and firm performance
under a resource‐based paradigm. Strategic Management Journal, 31(11), 1164-1182.
Lennartz, C., Haffner, M., & Oxley, M. (2012). Competition between social and market renting:
a theoretical application of the structure-conduct-performance paradigm. Journal of Housing and
the Built Environment, 27(4), 453-471.
Lukka, K. (2010). The roles and effects of paradigms in accounting research. Management
Accounting Research, 21(2), 110-115.
McWilliams, A., & Smart, D. L. (1993). Efficiency v. structure-conduct-performance:
Implications for strategy research and practice. Journal of Management, 19(1), 63-78.
Nandakumar, M. K., Ghobadian, A., & O'Regan, N. (2010). Business-level strategy and
performance: The moderating effects of environment and structure. Management
Decision, 48(6), 907-939.
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Olson, E. M., Slater, S. F., & Hult, G. T. M. (2005). The performance implications of fit among
business strategy, marketing organization structure, and strategic behavior. Journal of
marketing, 69(3), 49-65.
Ralston, P. M., Blackhurst, J., Cantor, D. E., & Crum, M. R. (2015). A structure–conduct–
performance perspective of how strategic supply chain integration affects firm
performance. Journal of Supply Chain Management, 51(2), 47-64.
Surroca, J., Tribó, J. A., & Waddock, S. (2010). Corporate responsibility and financial
performance: The role of intangible resources. Strategic management journal, 31(5), 463-490.
Tung, G. S., Lin, C. Y., & Wang, C. Y. (2010). The market structure, conduct and performance
paradigm re-applied to the international tourist hotel industry. African Journal of Business
Management, 4(6), 1116.
Bibliography
https://academic.oup.com/cje/article/33/4/609/1731235
http://policonomics.com/structure-conduct-performance-paradigm/
Berger, A. N., & Hannan, T. H. (1989). The price-concentration relationship in banking. The
Review of Economics and Statistics, 291-299.
Okeahalam, C. C., & Bah, I. (1998). Perceived Corruption and Investment in Sub‐Saharan
Africa. South African Journal of Economics, 66(3), 176-186.
MASON, E. S. (1939), Price and Production Policies of Large-Scale Enterprise, American
Economic Review, 29(1), Mar.
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A
p
p
e
n
d
i
x
Table 2: Composition of US Banking Sector
Number of Banks
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Year
Nationalized
Private
Others
Total
Domestic
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Foreign
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2000-01
29(22.8)
19(15.0)
34(26.8)
45(35.4)
127(100)
2001-02
29(23.6)
23(18.7)
35(28.4)
36(29.3)
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123(100)
2002-03
29(22.5)
24(18.6)
31(24.0)
45(34.9)
129(100)
2003-04
29(21.0)
22(15.9)
31(22.5)
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56(40.6)
138(100)
2004-05
29(20.9)
21(15.1)
31(22.3)
58(41.7)
139(100)
2005-06
29(22.7)
21(16.4)
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26(20.3)
52(40.6)
128(100)
2006-07
28(21.7)
26(20.2)
28(21.7)
47(36.4)
129(100)
2007-08
28(23.9)
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23(19.7)
26(22.2)
40(34.2)
117(100)
2008-09
28(25.2)
22(19.8)
24(21.6)
37(33.3)
111(100)
2009-10
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28(27.5)
16(15.7)
22(21.6)
36(35.3)
102(100)
Note:
Figures in parentheses indicate percentage share to total
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Table 2: Basic Conditions of US Banking Sector
Year
Market Size
Bank Size
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Average
C.V.
Average
C.V.
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2000-01
5.20
0.42
7.33
0.30
2001-02
5.36
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0.39
7.53
0.29
2002-03
5.24
0.44
7.36
0.33
2003-04
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5.19
0.45
7.41
0.32
2004-05
5.01
0.51
7.37
0.34
2005-06
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5.19
0.49
7.68
0.32
2006-07
5.18
0.52
7.65
0.35
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2007-08
5.69
0.46
8.14
0.33
2008-09
6.15
0.41
8.56
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0.30
2009-10
6.57
0.37
8.90
0.28
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Markets and competition
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Table 3: Structure of US Banking Sector
No. of
Market Share
n-firm
Entropy
year
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Concentration
HHI
bank
Average
C.V.
Index
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Ratio
2000-01
127
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0.01
2.65
0.32
0.06
3.58
2001-02
123
0.01
2.63
0.31
0.06
3.56
2002-03
129
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0.01
2.67
0.31
0.06
3.57
2003-04
138
0.01
2.75
0.32
0.06
3.58
2004-05
139
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0.01
2.77
0.32
0.06
3.54
2005-06
128
0.01
2.66
0.32
0.06
3.52
2006-07
129
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0.01
2.59
0.32
0.06
3.51
2007-08
117
0.01
2.26
0.31
0.05
3.55
2008-09
111
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0.01
2.21
0.31
0.05
3.54
2009-10
102
0.01
2.06
0.29
0.05
3.54
Note:
C.V. – Coefficient of Variation
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Table 4: Strategies of US Banks, 2000-01 to 2009-10
year
Selling Intensity
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Average
C.V.
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Markets and competition
2000-01
0.23
6.11
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2001-02
0.28
1.92
2002-03
0.30
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4.52
2003-04
0.34
2.16
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Markets and competition
2004-05
0.48
3.18
2005-06
0.65
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2.69
2006-07
0.79
2.38
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Markets and competition
2007-08
0.75
2.09
2008-09
0.78
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3.06
2009-10
0.48
3.59
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Note:
C.V. – Coefficient of Variation
Table 5: Performance of US Banks, 2000-01 to 2009-10
Year
PBIT/Income
PBIT/Asset
ROCE
Average
C.V.
Average
C.V.
Average
C.V.
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2000-01
65.67
0.32
7.43
0.36
7.21
2.98
2001-02
67.95
0.30
7.35
0.44
2.47
11.1
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2002-03
67.85
0.37
7.31
0.65
8.16
1.75
2003-04
66.43
0.36
7.09
0.64
7.75
1.79
2004-05
65.25
0.66
6.24
0.54
5.38
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10.0
2005-06
55.37
0.91
4.70
0.46
2.80
1.25
2006-07
62.06
0.22
5.80
0.47
5.28
1.48
2007-08
65.10
0.17
5.59
0.21
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5.92
1.21
2008-09
70.30
0.19
6.48
0.23
3.48
13.5
2009-10
72.30
0.20
6.96
0.91
7.32
1.09
Note: C.V. – Coefficient of Variation; PBIT – Profi t before Interests and Taxes; ROCE
– Return on Capital Employed Source: Prowess (CMIE)
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Table 6: Cost Efficiency of US Banks, 2000-01 to 2009-10
Operating
Total
Current Ratio
year
Expenditure/Income
Expenditure/Income
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Average
C.V.
Average
C.V.
Average
C.V.
2000-01
71.56
0.25
74.66
0.99
0.71
0.23
2001-02
71.86
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0.22
74.87
1.42
0.74
0.21
2002-03
67.53
0.26
70.30
1.51
0.71
0.27
2003-04
62.35
0.23
65.35
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1.50
0.69
0.20
2004-05
58.55
0.31
61.84
1.92
0.66
0.29
2005-06
59.06
1.87
63.39
2.71
0.94
1.78
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2006-07
60.83
7.07
64.86
2.77
1.26
7.07
2007-08
61.11
0.23
64.87
1.78
0.66
0.21
2008-09
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61.21
0.26
64.86
1.40
0.66
0.24
2009-10
61.20
0.26
64.86
2.50
0.65
0.24
Note:
C.V. – Coefficient of Variation
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Table 7: Baseline results
Depvar ROE ROE
conc1
0.3002
(0.000)
conc2
0.3242
(0.000)
MS
0.1312
(0.27)
0.1315
(0.27)
lnTA
1.0071
(0.034)
1.0105
(0.033)
lnTA2
–0.078
(0.010)
–0.0781
(0.010)
OPEFF
–0.0012
(0.031)
–0.0012
(0.032)
CA
–0.2518
(0.00)
–0.2517
(0.00)
CDTA
–0.0306
(0.37)
–0.0297
(0.39)
TIATA
–0.0206
(0.32)
–0.0205
(0.32)
PE
0.0141
(0.002)
0.0141
(0.002)
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Depvar ROE ROE
Observatio
ns 17,118 17,118
Table 8: Baseline results
Depvar ROE ROE
LD.depvar
0.0642
(0.008)
0.0644
(0.0080)
D.conc1
0.6375
(0.000)
D.conc2
0.7002
(0.000)
D.MS
1.0114
(0.000)
1.0117
(0.000)
D.lnTA
3.5096
(0.000)
3.489
(0.000)
D.lnTA2
–0.3357
(0.000)
–0.3357
(0.000)
D.OPEFF 0 (0.74) 0 (0.76)
D.CA
–0.0334
(0.24)
–0.0328
(0.25)
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