2013

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Working Paper 168 - Competition and Market Structure in the Zambian Banking Sector
26/02/2013 14:30
Working Paper 168 - Competition and Market Structure in the Zambian Banking Sector
This study evaluates the degree of competition in the Zambian banking sector in the wake of dynamic market shifts induced by entry of new foreign banks and privatisation of the state-owned bank. Using an unbalanced panel of bank level data complemented with market factors from 1998 to 2011, we measure using the Panzar-Rosse H-statistic and the time varying Lerner index, two non-structural measures mostly applied in the banking industry, see for instance. These indices are estimated across two periods with a view to assess whether or not increased foreign bank presence observed since 2008 and privatisation of the state owned bank in 2007 have had a discenible impact on competition in the Zambian banking setcor. We classify these periods as pre-entry/pre-privatisation and post-entry/post privatisation, respectively. Ther results are then compared. Zambia initiated far reaching financial sector reforms in 1992. The reforms brought great anticipation that competition in the banking system would be enhanced, thus leading to improved provision of financial services after many years of financial repression. However, expectations have been broadly at variance with practical observations. The banking system is concentrated and segmented with four largest banks controlling a third of the industry assets and about three quarters of the loans market. Intermediation margins are also wide, even by regional standards, despite marked improvements in macroeconomic conditions. Between 1998 and 2011, the average net interest margin was about 6% while the equivalent measure for return on assets stood at more than 4%. High profits and wide spreads are reminiscent of the high level of concentration in the sector. Nonetheless, commercial banks in Zambia have continued to show resilience after the banking crisis of the mid-1990s which saw closure of more than 6 banks. Currently, a majority of banks hold capital balances above the regulatory threshold, depicting the strength and stability of the Zambian banking sector. Thus, the failure of financial liberalisation to generate a 'critical level' of competitive pressure stems largely from the inherent nature of the Zambia banking system, with incumbent large foreign banks firmly entrenched in all segments of the market. However, concentration ratios distort the picture of competition because they do not offer adequate and conclusive explanations of actual bank behaviour. In view of this, appropriate measures are required to accurately assess banks’ exercise of market power and competitive conduct. Empirical results from the H-statistic show that Zambian banks earned their revenue under conditions of monopolistic competition. This finding is consistent with the estimate of the Lerner index which suggests that the degree of competitiveness may not be as low as previously understood, especially among foreign banks. Encouragingly, domestic banks also experienced intensification of competitive pressures over the sample period. Risk taking, revenue diversity and regulatory intensity are all important determinants of market power. Tight monetary policy is also found to strengthen the banks’ exercise of market power. Macroeconomic instability, denoted by inflaiton, limits banks’ competitive conduct while a large capital buffer is mainly aimed at maintaining banks’ solvency but it imposes a limit on competitive behaviour. The results also show that more geographically diversified banks have a higher propensity to raise revenue than those with a smaller branch network, and therefore useful in stimulating competition. Benchmarking Zambia against regional peers, the results show that Zambia ranked above countries of the EAC, except Kenya, which exhibited the highest degree of contestability in the region. Generally, the findings lend support to previous research suggesting that foreign bank penetration and privatisation can heighten competitive pressures in the banking sector. Thus, for policy purposes, the analysis shows that competitive conditions could be further enhanced by easing regulatory impediments and in the long-run, allowing more foreign bank participation could spur competitive conduct in the industry.Read more
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