Academic journal article IUP Journal of Applied Finance

Entry, Concentration and the Process of Competition: Early Days of Deregulating Private Banking Industry in India[dagger]

Academic journal article IUP Journal of Applied Finance

Entry, Concentration and the Process of Competition: Early Days of Deregulating Private Banking Industry in India[dagger]

Article excerpt

(ProQuest: ... denotes formulae omitted.)


The popular approaches for studying market concentration emerge from two perspectives:

* For the purpose of identifying market structure and market form; and

* For policy purposes such as antitrust laws and judgements.

The two shortcomings of these approaches are: Firstly, extant studies treat the impact of entry on concentration, market structure and competition rather mechanically; with some even going further to naively identify concentration as an indicator of competition. Secondly, in the case of antitrust laws, the relationship between concentration and monopoly is taken for granted and the judgements are pronounced about the market structure and form.

Neither of these approaches distinguishes between competition as a market form and competition as a process. Under the conditions of regulated markets, it is not possible to examine the process of competition because competition is either contrived by administered mechanisms or controlled by public monopolies. For the present study, the significance of concentration ratio lies in being able to analyze the banking industry in India. This is done with a view to understanding the process of competition unleashed by the deregulation of private banking industry. Accordingly, certain observations from the patterns of dynamics of the Herfindahl's Concentration Ratio (H) are highlighted in an attempt to generalize the process of competition.

The single most important component of the liberal policy package, ushered in the Indian banking industry, was to allow entry of private domestic banks in 1993. The underlying philosophy was that entry would reduce concentration and automatically instill the necessary competition. The objective of the present study is to analyze the evolution of the market structure of the Indian private domestic banking industry (henceforth referred to as the industry) consequent to entry of new banks. The study raises and attempts to answer the following questions.

* Is there a relationship between entry and market concentration?

* Is there a relationship between concentration and competition?

* What has been the trend in concentration in the industry?

* What are the determinants of concentration in the industry?

The Scenario of Private Domestic Banking in India: 1992-2002

The scenario in the industry on the eve of deregulation (till April, 1992) was characterized by administered interest rate and service charges as well as a tight credit allocation mechanism, coupled with restricted entry into private domestic banking sector. The situation of a private domestic sector bank, during this period, can be compared to an atomistic producer, whose status is that of a price taker, with the difference that the interest rate on liabilities and assets were not fixed by profit motive but by Reserve Bank of India (RBI) regulation through the system of administration spreads. A 'uniform price' was artificially prevalent during the regime. It may be appropriate to call the then market structure of the private domestic banking industry 'pseudo-competitive', in which profits were enjoyed by the banks due to the existence of administered spreads that could not be competed away by the new entrants. Apart from the regulation of interest rate, RBI also regulated the credit allocation by banks through different mechanisms. The presence of interest controls as well as rigorous credit allocation mechanisms eliminated price competition and the tendency toward optimal resource allocation. Credit allocation mechanisms included capital authorization scheme, credit-monitoring arrangement, consortium financing and lead bank system.

A committee of experts headed by M Narasimham submitted its report on Indian financial system in 1991. The salient features of the recommendations made by the committee include dismantling of administrative interest rates, service charges, and asset allocation mechanisms. …

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