Competition in Banking, Essay Example

Which is the most appropriate technique to measure competition in banking? Critically discuss making reference to theory and example.

To measure competitive states, it is reasonable to gain a holistic view of an analysis of the market structure, an understanding of non-structural NEIO approaches, and analysis of pricing behaviours. Based on these summative understandings, many different techniques have been developed to measure competition in banking. The Herfindahl Hirschman Index (HHI) can reasonably be used to gain an understanding of market concentration, which considers a larger weight for larger firms (Kerber et al., 2009). This is necessary to have a comprehensive understanding of market structure. Alternatively, the Lerner index could be used for this purpose, which assumes that the price of total assets is reflected by the ratio of total revenues to total assets.

Meanwhile, NEIO techniquies have developed to measure the competition or contestability of firms in the sector through the use of estimation of variables and the Rosse-Panzar statistic. Alternatively, correlation models can be used. There may be a relationship between concentration and profitability. In addition, the placement of firms and their quantity in particular geographic regions can impact their ability to compete as well. It is important to consider that there are many different factors that contribute to the ability to measure competition in banking. However, there is no truly best method for a particular purpose. In order to gain a comprehensive understanding of this relationship, it is ideal for analysts to consider a combination of quantitative and qualitative techniques, in addition to the series of methods mentioned.

Developing a standard to measure competition in banking could not reasonably reflect best practices, because it would not be accurate to create a one size fits all measurement. Therefore, it would be unreasonable to claim that one single method is the best or that one is better than another. Since the United States preferentially uses the Herfindahl Hirschman Index to measure concentration, this may be an ideal method of measuring this aspect of competition for Wall Street. However, this may not be the case for every geographic location, especially considering the banking market in areas that are less dense (Berger et al., 2004). While it is reasonable for bank competition to be measured similarly in some cases so that a point of comparison can be established, it is important to consider that different combinations of analytical methods may be necessary for different countries under the different economic requirements and practices imposed.

What influences competition in banking?

Ultimately, competition in banking and other industries is necessary because it ensure that provided services reflect a high quality and that the prices will be kept affordable and/or available according to the laws of supply and demand (Claessens, 2009). To ensure that the banking market is regulated in this manner, many countries have established anti-trust laws that ensure that competition exists between firms. Regulatory agencies are created to determine when uncompetitive conditions do exist and then take action to impose structural or behavioural sanctions. According to Martin, hit and run entry is the critical feature of a contestable market (Martin, 2000). Therefore, competition is present if an organization is reasonable vulnerable to new market entrants in a significant manner.

In the modern setting, it is important to understand the quality of the services that banks provide in part in terms of their technological innovation. Modern banks are more successful when they are able to offer their customers quick methods to transfer money. As a consequence, many modern banks have adopted virtual money transfer methods to keep up with their competition. It could be said that their services are constantly increasing because they wish to develop the latest technological trend in banking before their competitors do. Investment in terms of time and finances have the ability to contribute to this level of competition.

It is also important to consider that market structure in terms of geographic location has a small effect on competition in the banking industry, although this impact varies according to the country and region (Demirguc-Kunt et al., 2004). As internet banking becomes more prevalent, this aspect of competition will become significantly less relevant. Furthermore, it is also important to consider that customer service and conduct are important aspects of the competitive process. Customers are more likely to return to banks in which they have positive experiences and the support they need to complete their transactions. Furthermore, poor conduct has the ability to create negative press, which could in turn damage the reputation of the company and deter business.

Overall, competition is used to encourage companies to become more profitable that other organizations in the market. In the banking industry, this often means offering better services for a smaller price (Davies & Davies, 1984). The drive to be the most successful organization is what encourages competition and many different banks attempt to accomplish this by organizing their services and products in a manner that will appeal to the greatest number of people. However, a drive towards profitability also may result in a limitation on competitive rivalry in the form of monopolies to further increase profit (Ankerl, 1978).

Describe which circumstances can limit competitive rivalry within banking markets.

There are many factors that can contribute to a limitation on competitive rivalry within banking markets. In particular, the existence of trusts intrinsically limit competition because they are designed to ensure the profitability of banks in a manner that prevents new market entrants and other forms of competition. Even though these contribute to an enhanced degree of profitability, such partnerships are not seen as legal. In addition, the provision of information between competitive banks may limit competition if they use this information to avoid engaging in similar business practices. The degree of buyer power, the form of financial contracts, and the decision making abilities of banking customers can also reasonably contribute to a limitation of competitive rivalry. The degree to which trusts have an impact on the banking industry can be determined in part by the government’s that have control over their practices. In some cases, monopolies evolve due to a lack of regulations specifically stated in the law. This is an important contributing factor that provides insight into how the economy of a region could be impacted by the legal allowance of monopolies.

To avoid a limitation of competitive rivalry, it is important for a balance of power to exist between the organization and the consumer. If consumers or banks have too much power, then competitive rivalry will be limited. Instead, it is important for organizations to maintain a balance between these two parties to ensure that business transactions are mutually profitable and/or beneficial. When banks share information, they do so to determine how to best create their prices in order to persuade customers to use their services. As such, this information could be used to create services as well. In a situation with competition, these prices and services will be altered so that individual banks are able to offer their customers more than the competition. In situations in which monopolies are in place, this information is used to help the partner banks determine the highest prices and the least amount of services they can reasonably offer the public to yield maximum profits. As such, these partnerships between banks can significantly reduce the level of competition, contributing to diminished quality of services and increased prices for customers. It is also important to understand how these factors contribute to the limitation of competitive rivalry, discussed below.

Critically discuss how these circumstances can limit competitive rivalry.

There are many distinguishing features that make banks in a non-competitive environment attractive to potential customers. However, in situation where a monopoly is in place, there are no significant defining characteristics that direct consumers to make their selection. Instead, each bank offers similar advantages and disadvantages and the customer is forced to participate in these pre-selected packages based on agreements made by the banks that had formed a trust. In particular, competitive rivalry will be limited due to similar overdraft facilities, similar rates on various types of loans, the means by which money is deposited and withdrawn, and customer service representation. Furthermore, since competitive rivalry does not exist, the banks that participate in such a trust do not have to strive to provide high quality services, which can contribute to a diminished service at an increased price for the customer.

Currently, it is apparent that small and medium sized enterprises (SME’s) engage in monopoly practices that limit competitive rivalry. Monopolies are desirable because they lower risk and increase profits. Price discrimination reduces competitive rivalry because when financial institutions offer the same prices or rates, they are able to ask for higher prices overall (Armstrong & Vickers, 2012). Eliminating competition means that customers do not have an alternative option if they wish to acquire services more cheaply and by giving in to the demands of the monopoly, they are strengthening it in turn. Furthermore, new market entrants are blocked because the existing banks in the monopoly are well-established, are able to offer more comprehensive services, and have a greater access to customers. Thus, when new banks attempt to open, they cannot reasonably compete with the policies that the trust has established, preventing them from being able to enter the market as a new SME. Monopolies limit competition even more significantly when considering that the banks in these industries have several preferred vendors. These relationships often allow the banks to get better deals and prevent new market entrants from being able to negotiate the same type of bargain. Therefore, monopolies limit competition in the market at large due to the strength of the partnerships they establish and prevent new banks from establishing themselves. Overall, the benefits of establishing trusts is an increased profitability and a decreased concern about competition. To fight against these partnership, many governments have created laws that intend to breakup these partnerships and protect the rights of the consumer (Choi, 2007).

References

Ankerl G. (1978). Beyond Monopoly Capitalism and Monopoly Socialism. Cambridge, Massachusetts: Schenkman Pbl.

Armstrong M, Vickers J. (2012). Consumer Protection and Contingent Charges. Journal of Economic Literature, 50(2): 477–493

Berger AN, Demirguc-Kunt A, Levine R, Haubrich JG. (2004). Bank Concentration and Competition: An Evolution in the Making. Journal of Money, Credit, and Banking, 36(3): 433-451.

Choi JP. (2007). Recent Developments in Antitrust: Theory and Evidence. The MIT Press.

Claessens S. (2009). Competition in the Financial Sector: Overview of Competition Policies. Oxford Journals, 24: 83–118.

Davies G, Davies J. (1984). The revolution in monopoly theory. Lloyds Bank Review, (153): 38–52.

Demirguc-Kunt A, Laeven L, Ross L. Regulations, Market Structure, Institutions, and the Cost of Financial Intermediation. Journal of Money, Credit, and Banking, 36(3): 593-622.

Kerber W, Kretschmer J, von Wangenheim G. (2009). Market Share Thresholds and Herfindahl-Hirschman-Index (HHI) as Screening Instruments in Competition Law: A Theoretical Analysis. Retrieved from http://www.univie.ac.at/RNIC/papers/kerber_kretschmer_vwangenheim.pdf

Martin S. (2000). The Theory of Contestable Markets. Retrieved from http://www.krannert.purdue.edu/faculty/smartin/aie2/contestbk.pdf