The joint estimation of bank-level market power and efficiency

Abstract

The aim of this study is to provide a methodology for the joint estimation of efficiency and market power of individual banks. The proposed method utilizes the separate implications of the new empirical industrial organization and the stochastic frontier literatures and suggests identification using the local maximum likelihood (LML) technique. Through LML, estimation of market power of individual banks becomes feasible, while a number of strong theoretical and empirical assumptions are relaxed. The empirical analysis is carried out on the basis of EMU and US bank data and the results suggest small differences in the market power and efficiency levels of banks between the two samples. Market power estimates indicate fairly competitive conduct in general; however heterogeneity of market power estimates is substantial across banks within each sample. The latter result suggests that while the banking industries examined are fairly competitive in general, the practice of some banks deviates from the average behavior, and this finding has important policy implications. Finally, efficiency and market power present a negative relationship, which is in line by the so-called "quiet life hypothesis".JEL classification: L11; C14; G21

Revisiting the Quiet Life Hypothesis in Banking Using Nonparametric Techniques

“…On the one hand, the studies by Berger and Hannan (1998), Delis andTsionas (2009) andTurk Ariss (2010), among others, support the quiet life hypothesis, according to which managers would translate higher inefficiencies into higher prices-as opposed to the efficient structure paradigm, where best practice allows firms to earn market power. On the other hand, papers by Maudos and Fernán-dez de Guevara (2007), Casu and Girardone (2009), Fu and Heffernan (2009), and Koetter et al (2012, among others, reject that hypothesis.…”

“…However, according to her, one should be cautious about this result, if we consider that it is likely that the higher costs associated with market power are eventually channeled to bank clients which, in turn, may feed into higher prices and possibly boost bank profit efficiency. Similarly, Delis and Tsionas (2009), using a panel of EMU banks, report a negative relationship between cost efficiency and market power. Similar results were found by Coccorese and Pellecchia (2010), whose results support the quiet life in the context of Italian banking, although the impact of market power on efficiency was not particularly remarkable in magnitude.…”

“…However, in contrast to a less restrictive nonparametric approach, his analysis was entirely confined to the parametric field, therefore disallowing more flexible interpretations of the relationship. Some recent contributions have also dealt with the quiet life hypothesis and related issues, among which we can highlight the papers by Koetter et al (2012), Delis and Tsionas (2009), Casu and Girardone (2006), and Turk Ariss (2010. Although their objectives are not exactly coincidental with those of Clark (1986), they do neither consider flexible techniques to examine the links between efficiency and market power like we do.…”

Income-Specific Estimates of Competition in European Banking

“…Thus, there is no indication of 'quit life' hypothesis, according to which banks not vulnerable to intense competition, managers by no means seek to maximise profits through an everlasting cost reduction (Berger and Hannan, 1998;Delis and Tsionas, 2009). Rather pure efficiency hypothesis comes into play, which sets out the ability of efficient banks to engage in monopolistic pricing without intending to higher market shares.…”

A Study of the Determinants of Cost and Revenue Efficiency in the Context of Islamic and Conventional Banks: The Case of Malaysia from 2006 to 2012

“…Market competitiveness and efficiency + Berger and Hannan (1998), Delis and Tsionas (2009), Berger and Mester (2003) and Coccorese and Pellecchia (2010).…”