Competitive Conditions and Banking Stability in Pakistan: New Evidence from Market Power and Charter Value

Abstract

In this study, we invoke the theoretical notion of different competitive conditions in lending and deposit market power for the banking industry of Pakistan. We find highly monopolistic conditions in lending market whereby majority of the banks are enjoying high market power. On the other hand, the deposit market is found to be highly competitive. Subsequently, we find the effects of the lending and deposit market measures of market power on the riskiness of banks to be asymmetric. In addition, we introduce charter value as a determinant of banks’ risk for the first time in the case of Pakistan and tested for whether or not greater higher valuable charters enhance the risk aversive tendencies of banks to preserve charter value? Our findings suggest that the theoretical link between charter value and market power is sufficiently strong to restrain risky behavior of banks.

Finclusion: The nexus of Fintech and financial inclusion against banks’ market power

“…However, the significantly higher Lerner margins indicates higher market power and warrants that further competition should be induced to improve the competitive conditions of the banking industry. These findings are consistent with [ 33 , 34 ].…”

“…The degree of market power is inversely related to competition, higher market power indicates low competition and vice versa. Market power is usually estimated through Lerner Index which indicates a relative differential between input prices and marginal costs vis a vis a firm's output prices and is thus inversely related to competition [ 33 , 34 ]. There are other several measures to estimate the degree of competition in the banking industry such as the Panzer and Rosse H-Statitics, and the Boone Indicator.…”

“…The Boone indicator in particular is time dependent and reflects the logic behind structure efficiency hypothesis [ 35 ]. However, in this study, we invoke the theory behind structural conduct performance (SCP) hypothesis owing to neo-organizational approach [ 33 , 36 ]. Similarly, the H-Statistic is a non-structural measure of competition (Apergis, 2015).…”

“…We follow the same line of literature and to measure banks’ market power, a localized Lerner Index for Pakistani banks has been estimated following [ 3 , 33 , 34 , 37 , 38 ] and express the Lerner index using equation (1) as inverse of the price elasticity as such that: Where represent output prices and represents the marginal costs. All the variables follow the definitions provided in Table 1 accordingly.…”

“…We adopt panel regression estimation techniques with bank level fixed effects for our models (equation (7) to equation (14) ) commensurate with the literature [ 33 , 34 ]. Owing to the fact that there is a possibility of the presence of bank level heterogeneity.…”