Credit Reporting - World Bank

Credit Reporting - World Bank

Bank Competition: What is the Role of the Government? Csar Caldern (FPDCE), Maria Soledad Martnez Pera (DECFP), Mauricio Pinzn Latorre (FPDCE), Klaus Schaeck (Bangor University) Roadmap 1. 2. 3. 4. 5. 6. 7. Motivation Key messages Measurement and trends in banking competition Banking competition and financial development Drivers of banking competition Additional background work for the Chapter Conclusions and policy implications 2. Key messages Greater bank competition can: Quality of regulatory framework is key to guarantee: Greater market contestability Positive side effects from enhanced competition Government may play a role in enhancing competition by designing policies that: Raise bank efficiency Enhance access to financial services Promote bank stability Build a strong institutional framework Guarantee market contestability Design of entry/exit policies, prudential regulation and supervision should shape incentive framework that minimizes excessive risk-taking in the face of greater competition. 3. Measurement and trends in bank competition

Goal: Assemble a comprehensive array of indicators of banking competition. Data source: Bankscope Three types of indicators Structural measures (SCP paradigm): Market structure Share of assets held by the k largest banks (k=3, 5) Herfindahl-Hirschman index (assets- and loan-based) Contestability measures: ease of entry and exit Requirements for bank licenses Share of licenses denied Non-structural measures (New empirical IO): Market power H-Statistic Lerner Index 3. Measurement and trends in bank competition H-Statistic (Panzar & Rosse, 1982, 1987) Elasticity of bank interest revenues to input prices Greater values of H implies more intensive banking competition (under certain conditions) Valid only if market in long-run equilibrium Lerner Index (Lerner, 1934) Divergence between prices and marginal costs Not a long run equilibrium measure We can build a time series Limitations of measures of competition Structural features of markets irrelevant as long as markets are contestable Measures used are country-level, but competition may vary by product and by markets, where markets may be defined at the state or country level 3. Trends in competition: Market concentration Asset share of 5 largest banks (CR5) Industrial and Developing Countries

0.90 0.85 0.80 0.75 0.70 0.65 0.60 0.55 0.50 1996-10 2000-07 Industrial Countries 2000-10 Developing Countries Source: GFDR Teams calculation based on data from Bankscope. Median values across country groups are reported. 3. Trends in competition: Market concentration Asset share of 5 largest banks (CR5) Across Developing Regions, 1996-2010 (Average) 100 95 90 85 80 75 70 65 60 55 50 AMER EAP ECA Non-GCC MENA GCC MENA SA SSA Source: GFDR Teams calculation based on data from Bankscope. Median values across country groups are reported. 3. Trends in Competition: Contestability Barriers to Entry Industrial vs. Developing Countries 8 Share of denied licenses Industrial vs. Developing Countries 25 7 20

6 5 15 4 10 3 2 5 1 0 Industrial Countries Developing Countries 2001 2010 0 Industrial Countries 2001 Developing Countries 2010 Note: The index of entry into banking requirements captures whether various types of legal submissions are required to obtain a banking license. Higher scores indicate higher restrictions on entry into banking. On the other hand, the share of denied licenses is the ratio of denied to total banking licensing requests. Source: Bank regulation and supervision survey (Barth, Caprio and Levine, 2001, 2004, 2006, 2012). Elaboration: GFDR Team. 3. Trends in Competition: Contestability Barriers to Entry By Developing Regions Share of denied licenses By Developing Regions 9 90 8 80 7 70 6 60 5 50 4 40

3 30 2 20 1 10 0 0 AMER EAP ECA Non-GCC MENA 2001 2010 GCC MENA SA SSA AMER EAP ECA Non-GCC MENA 2001 GCC MENA SA SSA 2010 Note: The index of entry into banking requirements captures whether various types of legal submissions are required to obtain a banking license. Higher scores indicate higher restrictions on entry into banking. On the other hand, the share of denied licenses is the ratio of denied to total banking licensing requests. Source: Bank regulation and supervision survey (Barth, Caprio and Levine, 2001, 2004, 2006, 2012). Elaboration: GFDR Team. 3. Trends in Competition: H-Statistic H-Statistic: Industrial and Developing Countries 0.65 0.60

0.55 0.50 0.45 0.40 1996-2007 2000-2007 Industrial Countries 2000-2010 Developing Countries Note: H-Statistic figures are calculated for commercial banks based on data from Bankscope and following the methodology described in Demirguc-Kunt and Martnez-Pera (2010). Elaboration: GFDR Team. 3. Trends in Competition: H-Statistic H-Statistic Across Developing Regions, 1996-2007 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0.0 Latin America East Asia & the Pacific Eastern Europe & Central Asia Non-GCC MENA GCC MENA South Asia Sub-Saharan Africa Note: H-Statistic figures are calculated for commercial banks based on data from Bankscope and following the methodology described in DemirgucKunt and Martnez-Pera (2010). Elaboration: GFDR Team. 3. Trends in Competition: Lerner Index Annual Evolution: Industrial vs. Developing Countries Period averages: Industrial vs. Developing Countries Median Industrial

Countries Mean 1996-2007 2000-2007 2000-2010 0.206 0.213 0.209 0.193 0.200 0.193 Developing 1996-2007 Countries 2000-2007 2000-2010 0.218 0.237 0.219 0.195 0.216 0.210 Source: GFDR Teams calculation based on data from Bankscope following the methodology described in Demirguc-Kunt and Martnez Pera (2010). 3. Trends in Competition: Lerner Index Lerner Index Across Developing Regions 0.55 0.50 0.45 0.40 0.35 0.30 0.25 0.20 0.15 0.10 1996 1997 1998 LAC 1999 EAP 2000

2001 ECA 2002 2003 2004 Non-GCC MENA 2005 2006 GCC MENA 2007 2008 SA 2009 2010 SSA Source: GFDR Teams calculation based on data from Bankscope following the methodology described in Demirguc-Kunt and Martnez Pera (2010). 3. Trends in Competition: Concentration vs. Competition H-Statistic vs. CR5 Lerner Index vs. CR5 1.2 0.6 y = 0.0235x + 0.5703 R = 0.0004 y = 0.2183x + 0.048 R = 0.1458 0.5 Competition: Lerner Index Competition: H-Statistic 1 0.8 0.4 0.6 0.3 0.4 0.2

0.2 0.1 0 0 -0.2 0.2 0.4 0.6 0.8 1 0 0 Concentration CR5 0.2 0.4 0.6 Concentration CR5 0.8 Source: GFDR Teams calculation based on data from Bankscope following the methodology described in Demirguc-Kunt and Martnez Pera (2010). 1 4. Banking competition and financial development Bank competition can impact various dimensions of financial development such as efficiency, access, and stability. Efficiency Alternative theories on the competition-efficiency nexus Quiet Life (Hicks, 1935) without competition banks relax their efforts to control costs. Efficient Structure (Demsetz, 1973) points to reverse causation between efficiency and concentration: more efficient firms are able to gain greater market shares. Studies focusing on direct measures of competition or contestability show that competition brings about efficiency improvements. Developed countries (Schaeck and Cihak, 2011; Evanoff and Ors, 2008; Demirguc-Kunt et al. , 2004) Developing countries (Lin, Ma and Song, 2010; Turk-Ariss, 2010) 4. Banking competition and financial development Access Ambiguous theoretical prediction for competition-access link Market power hypothesis argues that competition in the banking market reduces the cost of finance and increases the availability of credit. Information hypothesis argues that, in the presence of information asymmetries and agency costs, competition can reduce access by making it more difficult for banks to internalize the benefits of investing in building lending relationships, in particular, with opaque clients (Petersen and Rajan, 1995;

Marquez, 2002). Evidence between concentration and access yields mixed result. But, studies using direct measures of competition find that competition improves access (see Claessens and Laeven, 2005; Carb et al. 2009). 4. Banking competition and financial development Stability Competing theories explaining competition-stability relationship Competition-fragility view predicts that competitive banking systems are less stable, because competition reduces bank profits and erodes the charter value of banks, increasing banks incentives for excessive risk-taking (see Marcus, 1984; Chan, Greenbaum and Thakor, 1986; and Keeley, 1990). Competition-stability view argues that since in less competitive sectors banks can charge higher interest rates, this may induce firms to assume greater risk, resulting in a higher probability that loans become nonperforming. Similarly, higher interest rates might attract riskier borrowers through the adverse selection effect (Boyd and De Nicol, 2005). 4. Banking competition and financial development Stability. Early country specific bank-level studies yield mixed results. Three strands of recent studies provide evidence of positive link between competition and stability. Regulatory restrictions on bank entry and exit promote systemic banking distress (Beck, Demirguc-Kunt and Levine, 2006 a, b) Bank competition (H-Statistic) reduces systemic bank fragility (Schaeck, Cihak and Wolfe, 2009) Competition (Lerner index) is associated with greater systemic stability (Anginer, Demirguc-Kunt, and Zhu, 2011). OECD Competition Committee. Design and application of better regulations (rather than competition policies) to promote banking stability. 4. Banking competition and financial development Depth 100 Lerner Index Across Developing Regions 75 50 25 Access Efficiency 0 Stability High Competition Low Competition Source: High (low) competition is defined as the bottom (top) quartile of the country distribution of the Lerner index (country median across banks over the period 1996-2010). Elaboration: GFDR Team 4. Banking competition and financial development Industrial Countries Developing Countries Depth 100

Depth 100 Access 75 75 50 50 25 25 Efficiency 0 Stability High Competition Access Efficiency 0 Stability Low Competition High Competition Low Competition Source: High (low) competition is defined as the bottom (top) quartile of the country distribution of the Lerner index (country median across banks over the period 1996-2010). Elaboration: GFDR Team 5. Drivers of Banking Competition Cross-section analysis of the drivers of banking competition Choice of drivers follows the literature (Claessens and Laeven, 2004; Anzoategui, Martinez-Pera and Rocha, 2010; Demirguc-Kunt and Martnez-Pera, 2010, among others) Focus on the role of the State As market participant. Presence of government-owned banks (GOBs) As regulator. Entry barriers to the industry Overall activity restrictions Transparency and disclosure requirements As enabler of a market-friendly environment. Overall strength of the institutional framework Quality of credit information 5. Drivers of banking competition Contestability and Institutional Framework Variables Contestability - Entry barriers - Share of bank licenses denied

- Restrictions on bank activities - Minimum entry capital required (in logs ) Ownership - Government bank participation - Foreign bank participation [1] [2] [3] [4] [5] [6] 0.0442** [0.018] 0.0129 [0.032] 0.0045 [0.005] .. 0.0480** [0.019] 0.0160 [0.032] 0.0047 [0.005] 0.0031*** [0.001] 0.0410** [0.020] -0.0041 [0.037] 0.0022 [0.006] 0.0033*** [0.001] 0.0383** [0.019] -0.0042 [0.035] 0.0003 [0.006] 0.0028*** [0.001] 0.0410** [0.019] 0.0004 [0.033] 0.0008 [0.006] 0.0031*** [0.001]

0.0413** [0.020] -0.0072 [0.035] -0.0005 [0.006] 0.0034*** [0.001] 0.0393** [0.019] -0.0062 [0.034] -0.0017 [0.006] 0.0031*** [0.001] 0.0242 [0.048] .. 0.0255 [0.048] .. 0.0010 [0.048] .. -0.0127 [0.045] -0.0478 [0.029] -0.0038 [0.044] -0.0389 [0.029] -0.0195 [0.042] -0.0323 [0.028] -0.0119 [0.042] -0.0467 [0.030] -0.0157** [0.007] .. .. .. .. .. ..

Macroeconomy and Institutional Framework - Real GDP per capita .. .. - Rule of Law .. .. -0.0133* [0.007] .. - Regulatory quality .. .. .. .. -0.0195* [0.010] .. - Control of corruption .. .. .. .. .. Observations R-squared [7] 80 0.056 80 0.063 80 0.097 80 0.125 80 0.115

-0.0336*** [0.012] .. 80 0.152 .. -0.0274** [0.011] 80 0.148 Robust standard errors in brackets. *** p<0.01, ** p<0.05, * p<0.1 Note: The dependent variable is the Lerner index for the country computed over the 1996-2010 period. Regressions were estimated using least squares with robust standard errors (White, 1980). Elaboration: GFDR Team 5. Drivers of Banking Competition Transparency and depth of credit information Variables [1] [2] 0.0311* [0.017] -0.0129 [0.036] 0.0013 [0.005] 0.0023** [0.001] 0.0317* [0.017] -0.0117 [0.035] 0.0013 [0.005] 0.0025** [0.001] Transparency and depth of credit information - Depth of credit information -0.0125** [0.005] - Bank auditing requirements .. -0.0135** [0.006] .. Contestability - Entry barriers - Share of bank licenses denied - Restrictions on bank activities - Minimum entry capital required (in logs ) - Bank disclosure

.. Ownership - Government bank participation -0.0117 [0.042] - Foreign bank participation -0.0471 [0.030] Macroeconomy and Institutional Framework - Real GDP per capita -0.0109 [0.008] - Rule of Law .. [3] [4] [5] [6] [7] [8] 0.0333* [0.018] -0.0156 [0.036] 0.0004 [0.005] 0.0028*** [0.001] 0.0308* [0.018] -0.0168 [0.036] -0.0008 [0.006] 0.0026** [0.001] 0.0246 [0.020] -0.0257 [0.038] 0.0017 [0.006] 0.0020 [0.001] 0.0239 [0.020] -0.0278 [0.036] 0.0017 [0.006] 0.0023*

[0.001] 0.0278 [0.020] -0.0353 [0.038] 0.0007 [0.005] 0.0029** [0.001] 0.0229 [0.020] -0.0314 [0.036] -0.0005 [0.006] 0.0022* [0.001] -0.0117** [0.006] .. -0.0126** [0.005] .. -0.0124** [0.006] 0.0106 [0.018] 0.0154 [0.016] -0.0137** [0.006] 0.0112 [0.018] 0.0181 [0.016] -0.0113* [0.006] 0.0091 [0.018] 0.0241 [0.017] -0.0127** [0.006] 0.0113 [0.018] 0.0166 [0.016] .. .. .. -0.0088

[0.040] -0.0406 [0.030] -0.0191 [0.040] -0.0357 [0.029] -0.0155 [0.039] -0.0473 [0.031] 0.0017 [0.051] -0.0422 [0.032] 0.0054 [0.049] -0.0313 [0.031] -0.0061 [0.047] -0.0206 [0.030] -0.0013 [0.048] -0.0390 [0.033] .. .. .. .. .. .. .. .. -0.0158* [0.009] .. .. .. -0.0264* [0.013] .. ..

.. -0.0229* [0.012] .. - Regulatory quality .. -0.0157 [0.011] .. - Control of corruption .. .. Observations 78 78 R-squared 0.180 0.182 Robust standard errors in brackets. *** p<0.01, ** p<0.05, * p<0.1 78 0.201 78 0.206 77 0.186 -0.0259** [0.012] .. .. 77 0.199 -0.0435** [0.016] .. 77 0.235 .. -0.0309** [0.012] 77 0.226 Note: The dependent variable is the Lerner index for the country computed over the 1996-2010 period. Regressions were estimated using least squares with robust standard errors (White, 1980). Elaboration: GFDR Team 5. Drivers of Banking Competition Inter-industry competition and market structure

Variables Contestability - Entry barriers - Share of bank licenses denied - Restrictions on bank activities - Minimum entry capital required (in logs ) Market Structure - CR3: Asset share of 3 largest banks [1] [2] 0.0308* [0.017] 0.0290 [0.031] -0.0007 [0.006] 0.0027*** [0.001] [3] 0.0316* [0.018] 0.0288 [0.030] -0.0011 [0.006] 0.0030*** [0.001] [4] 0.0347* [0.020] 0.0245 [0.032] -0.0019 [0.006] 0.0034*** [0.001] 0.0308 [0.019] 0.0223 [0.031] -0.0027 [0.006] 0.0030*** [0.001] [5] [6] [7] [8] 0.0348*

[0.018] 0.0275 [0.032] 0.0010 [0.006] 0.0025** [0.001] 0.0347* [0.020] 0.0233 [0.031] 0.0006 [0.006] 0.0026** [0.001] 0.0391* [0.021] 0.0200 [0.032] -0.0000 [0.006] 0.0031** [0.001] 0.0347* [0.020] 0.0138 [0.032] -0.0012 [0.006] 0.0026** [0.001] .. .. .. .. 0.0318 [0.042] 0.0493 [0.044] 0.0502 [0.044] 0.0610 [0.046] -0.0225 [0.022] -0.0192 [0.021] -0.0108 [0.019]

-0.0110 [0.020] -0.0169 [0.022] -0.0078 [0.019] -0.0001 [0.017] 0.0054 [0.017] -0.0635* [0.037] - Foreign bank participation -0.0541* [0.031] Macroeconomy and Institutional Framework - Real GDP per capita -0.0090 [0.009] - Rule of Law .. -0.0609 [0.040] -0.0488 [0.030] -0.0643 [0.040] -0.0407 [0.029] -0.0666 [0.040] -0.0533* [0.031] -0.0565 [0.038] -0.0636* [0.032] -0.0528 [0.041] -0.0602* [0.031] -0.0558 [0.041] -0.0513* [0.029] -0.0582 [0.042] -0.0696** [0.032]

.. .. .. .. .. .. .. .. -0.0102 [0.009] .. .. .. -0.0305* [0.016] .. .. .. -0.0216* [0.011] .. -0.0234* [0.012] .. .. Inter-Industry competition - Stock market capitalization (ratio to GDP) Ownership - Government bank participation - Regulatory quality .. -0.0157 [0.011] .. - Control of corruption .. ..

Observations 66 66 R-squared 0.128 0.137 Robust standard errors in brackets. *** p<0.01, ** p<0.05, * p<0.1 66 0.168 66 0.162 65 0.149 65 0.170 -0.0367** [0.017] .. 65 0.205 .. -0.0326** [0.013] 65 0.212 Note: The dependent variable is the Lerner index for the country computed over the 1996-2010 period. Regressions were estimated using least squares with robust standard errors (White, 1980). Elaboration: GFDR Team 5. Drivers of Banking Competition: Explaining differences in the Lerner index vis--vis High Performer Developing Countries Actual Difference in H Explaining differences in Lerner relative to Top Quartile Latin East Eastern Middle South America Asia Europe East Asia Sub-Saharan Africa -0.0498 -0.0101 -0.0565

-0.0187 -0.1114 0.0264 -0.0917 -0.0046 0.0043 -0.0008 0.0000 -0.0046 0.0052 -0.0008 0.0000 -0.0046 0.0005 -0.0010 -0.0008 -0.0046 0.0039 -0.0004 0.0000 -0.0046 0.0052 -0.0008 -0.0001 0.0000 0.0122 -0.0012 -0.0001 -0.0046 0.0062 -0.0008 0.0000 Transparency and depth of credit information - Depth of credit information -0.0134 0.0000 0.0000 -0.0134 -0.0276 -0.0192 -0.0368 Ownership - Government bank participation - Foreign bank participation

0.0032 -0.0106 0.0019 -0.0091 0.0063 -0.0151 0.0053 0.0000 0.0020 -0.0147 0.0123 -0.0149 0.0018 -0.0106 Institutional Framework - Regulatory quality -0.0232 -0.0238 -0.0103 -0.0208 -0.0200 -0.0394 -0.0336 Unexplained Difference -0.0046 0.0211 -0.0315 0.0113 -0.0507 0.0768 -0.0134 Contestability - Entry barriers - Share of bank licenses denied - Restrictions on bank activities - Minimum entry capital required Note: We report the explained differences in the Lerner index between the median values of the policy drivers for the selected developing regions vis--vis the higher performer in competition and its drivers. The high performer is computed as the top quartile of the overall sample distribution of the Lerner index and its determinants.

5. Banking Competition: Australia Competitive dynamics altered by global financial crisis (GFC) Non-ADI lenders share loss in mortgage lending markets (securitization) Slower growth/ withdrawal of foreign banks operations Strong growth in deposits (supported governments deposit guarantee) Rising use of long-term wholesale debt and reduced short-term exposure. Demand for deposits by ADI rather than short-term / long-term wholesale funding. Initiatives to improve competition Securitization markets. Government investment in RMBS (up to US$ 8 bn.) Account switching package. Lift impediments to customers ability to switch banks. Trade practices amendment Bill. It forbids the use of unfair terms in standard-form consumer contracts. Courts allowed to void unfair terms. National consumer credit protection reform (First phase) Licensing regime for providers of consumer credit and credit services. Responsible credit conduct obligations Expanded consumer protection through special court arrangements. 5. Banking Competition: South Africa Banking Enquiry (Dec. 2006) initiated by the Competition Commission

Focus: Retail banking Payment systems Disproportionate market power of Big 4 banks (despite not having 30+ % share in any product category) Very high cost structures (i.e. fixed and common costs) Product differentiation and price complexity are very high. Large information gaps Low customer switching Policy recommendations Purpose-designed regime for regulating non-banks access to payments system Establish regulator to determine need to inter-change any card/EFT transaction and regulating relevant fees. Regulating penalty fees for dishonored debit orders Replacing current inter-bank pricing model for automated cash machines with direct charging model (e.g. AUS) Introduce account switching codes to reduce costs of switching providers. 6. Additional background work for the Chapter Anginer, Demirguc-Kunt and Zhu (2012) Reassess bank competition - systemic stability nexus Focus on systemic risk rather than risk of individual banks Banks take on more diversified risks with greater competition, and system is less vulnerable to shocks. Institutional and regulatory environment has a direct effect and an amplifying effect on systemic stability Caldern and Schaeck (2012)

Policymakers calling for increasing competition in the aftermath of rescue operations during ongoing crisis (OECD, 2009; Independent Commission on Banking, 2011) Examine the effects of State interventions on banking competition Interventions: (a) blanket guarantees, (b) liquidity support, (c) recapitalization, and (d) nationalizations. 7. Conclusions and policy implications Government may play a key role in enhancing competition in the financial sector Government should set up and implement policies that: Ensure greater market contestability Low barriers to entry and exit Promote deeper financial markets Development of NBFIs Promote bank transparency Role for market discipline Greater bank competition raises efficiency and soundness, and allows a more efficient resource allocation Competition per se does not generate financial instability in countries with robust institutional frameworks Harmful if regulations allow for excessive risk-taking Generous deposit insurance may elevate risk-taking incentives

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