Academic journal article Journal of Money, Credit & Banking

Banks as Multioutput Oligopolies: An Empirical Evaluation of the Retail and Corporate Banking Markets

Academic journal article Journal of Money, Credit & Banking

Banks as Multioutput Oligopolies: An Empirical Evaluation of the Retail and Corporate Banking Markets

Article excerpt

The distinction between retail and corporate banking markets is of much importance in real life banking organizations. The two markets differ with respect to concentration, the importance of informational asymmetries, and the extent of customer mobility. Within a standard conjectural variation model estimated on cost-efficient banks as well as on the full sample of banks, we empirically characterize the strategic behavior in each of these markets, and also focus on cross-market interactions to see whether initial moves in one market affect the equilibrium in the other market. We compare our findings to the predictions that would follow from merely considering concentration ratios, such as the Herfindahl index.

One of the major interests expressed by researchers who are engaged in empirical banking studies is the assessment of the competitive viability of the industry. For over a decade of research in the area, researchers have tried to address this issue by applying various methods to differing data sets for the purpose of estimating the degree of scale economies. Realizing the multiplicity of products in banking, recent research has also focussed on the proper measurement of product mix economies or what has been termed economies of scope.(1) This line of research has been centered on the properties of the cost function, and most studies have not incorporated the market influences on the behavior of banks, and the potential impact of these forces on competitive viability and behavior of the industry. Very recent literature has been testing for competition and market power in the banking sector. Although market power may be inferred from various concentration ratios such as the Herfindahl index, these measures may not accurately depict the true market power. The purpose of the present paper is to investigate these market influences, focussing on the degree of market power and on the interactions between different market segments in an oligopolistic market setting.

Multioutput banking firms sell their outputs in a number of different market segments, which are characterized by customers of differing informational gathering and processing abilities and mobility across product characteristics. These differences are important reasons why banks may develop different strategic behavior across market segments, perhaps characterized by some kind of retaliation (Porter 1980; Salop and Scheffman 1983) or forbearance (due to fear of retaliation).(2) Recent studies of such behavior in banking markets include Spiller and Favaro (1984), Hancock (1986), Gelfand and Spiller (1987), Shaffer (1993), Shaffer and DiSalvo (1994), and Berg and Kim (1994). Only the paper by Gelfand and Spiller includes a cross-market analysis of oligopolistic competition. None of the papers, however, take into account the possibility that X-inefficiency may make their optimization models irrelevant, as will be the case for inefficient banks that are not on their frontier cost function.

In this study we focus on cost-efficient banks in order to avoid that pitfall. We further attempt to uncover the oligopolistic behavior of multioutput banks that sell their outputs in two distinct markets common to all banking industries, namely, retail and corporate banking markets. That distinction is new to this line of study,(3) and its rationale is based on two main observations. First and generally, the distinction between these activities (outputs) is intrinsic to the operation of banks and is of much importance in practice. In fact, banks that are more retail oriented tend to rely more heavily on produced deposits, and thus use more extended branching networks, whereas banks which are more oriented toward corporate customers tend to rely more heavily on the purchase of funds rather than on produced deposits.(4) Second, these activities reflect different types of customers who differ substantially with respect to their ability to gather and process the relevant information in financial markets and therefore their mobility across banks differs. …

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