Market structure, conduct and performance: Evidence from the Bangladesh banking industry

https://doi.org/10.1016/j.asieco.2007.12.007Get rights and content

Abstract

With regard to the market structure and performance in Bangladesh banking industry, there are two competing hypotheses—the traditional structure–conduct–performance (SCP) hypothesis and the efficiency hypothesis (EH). Using pooled and annual data for the period 1999–2002, this study tests the validity of these two hypotheses. In general, the results of this study support the EH hypothesis as an explanation for market performances in Bangladesh, but for definitive policy purposes, the impact of the banking structure needs to be explored further.

Introduction

In bank performance literature, two competing hypotheses have been the subject of controversy for more than 40 years. The oldest hypothesis is the traditional structure–conduct–performance (SCP), also known as structure-performance (SP), hypothesis. According to SP hypothesis (Gilbert, 1984, Hannan, 1991), the profitability of a banking firm is dependent upon the market structure and the level of competition. The lower the level of competition in the market, the higher the economic rent for a firm. The basic message of the SP hypothesis is that a higher concentration ratio leads to a higher profitability. The hypothesis that concentration leads to higher profitability has been challenged by an alternative hypothesis, known as the efficiency hypothesis (EH). The EH emphasizes superior efficiency as an explanation for a firm's profitability. According to EH, “there is no relationship between concentration and profitability, but rather market share and bank profitability” (Smirlock, 1985, p. 69). In other words, the performance of an individual firm depends on the firm's degree of efficiency. In this hypothesis, the explanation for the relationship between the market structure and performance of a firm is dependent upon the firm's efficiency. If a firm enjoys a higher degree of efficiency than its competitors (that is, if the firm has a relatively low cost of production structure), the firm can maximize profits and increase its size and market share. This can be done by keeping the present market price level. Thus, the increase of profits and market share is the result of efficiency, not of a higher concentration ratio (collusion). The proponents of both hypotheses claim support in their favor.

There are three motivating factors that brought about this study. First, given the controversy between the two competing hypotheses, it is important to determine which hypothesis truly approximates and describes the Bangladesh banking industry. Determining the approximate behavioral relationship has important policy implications for Bangladesh because the presumed positive relationship between the market concentration and higher performance, for example, higher profits influences regulatory decisions regarding mergers and de novo entry. Increasing market concentration is also considered a social cost. Second, the relevance of the two hypotheses has been explored and tested in the context of the bank markets in developed countries. This study evaluates the validity of the two hypotheses in the context of the banking market in Bangladesh, a third-world country. Until 1980, the banking system of Bangladesh was quite concentrated and was regulated and protected from foreign competition. The domestic bank market was dominated by the operation of five nationalized commercial banks. This fact was conducive to collusive bank behavior leading to higher profitability. Thus, Bangladesh provides a good test case for evaluating the validity of the two competing hypotheses. Third, since the controversy of SCP and EH has not been resolved, the hypotheses deserve further exploration. This study can contribute to new findings in the banking performance literature.

This paper is structured as follows: Section 1 provides a brief description of the institutional structure of the Bangladesh banking market. Section 2 describes SCP and EH in the context of market structure and performance relationship. Section 3 provides data and methodology. Section 4 reports results and conclusions.

Section snippets

Institutional structure of the Bangladesh banking market

Bangladesh is a small country bordering India. The country seceded from Pakistan and gained independence in 1971. At that time, all commercial banks were nationalized by the government without compensation. The question of compensation did not arise at this time because the owners of the commercial banks were non-Bengalis who left Bangladesh before or during the war of liberation. The banking system of Bangladesh was highly regulated and protected from foreign competition and was concentrated

Structure-performance relationship and background of controversy

The notion that market structure influences a firm or industry performance originates in the classical model of the theory of firm. In a pure competitive model, there are a large number of firms. The larger the number of firms, the higher the competition and lower the concentration ratio. The lower the concentration ratio, the lower the profit rates for a firm. Each firm's market share is insignificant and its product homogenous. Because of these factors, firms cannot influence market price. In

Empirical results

Three types of regressions were computed with cross-sectional data for 42 banks in Bangladesh. First, liner regressions were estimated with pooled data for 1999–2002. Regressions 1–12 in Table 2 report the results of the pooled data for 1999–2002.

Conclusions

The two hypotheses – SCP and ESH – are examined in the context of the assets and deposit market in Bangladesh. The results were presented from the tests of these hypotheses using both pool and annual data. Although three or four of the largest banks in Bangladesh dominated and controlled 50–62% of the total assets and deposits, their ROA and ROE are not satisfactory. One of the three largest banks in Bangladesh, Rupali bank, was operating with losses. Therefore, the coefficients of CR are, in

References (29)

  • S. Rhoades

    Welfare loss, redistribution effects, and restriction of output due to monopoly

    Journal of Monetary Economics

    (1982)
  • J.S. Bain

    Relation of profit rate to industry concentration: American manufacturing, 1936–1940

    Quarterly Journal of Economics

    (1951, August)
  • E. Brucker

    A microeconomic approach to banking competition

    Journal of Finance

    (1970, December)
  • Y. Brozen

    Concentration, merger and public policy

    (1982)
  • H. Demsetz

    Industry structure, market rivalry, and public policy

    Journal of Law and Economics

    (1973)
  • F.R. Edward

    Concentration in banking and its effect on business loan rates

    Review of Economic and Statistics

    (1964, August)
  • D.D. Evanoff et al.

    Reevaluation of the structure–conduct performance paradigm in banking

    Journal of Financial Services Research

    (1988)
  • D.R. Fraser et al.

    More on banking structure and performance; the evidence from Texas

    Journal of Financial and Quantitative Analysis

    (1971)
  • T.G. Fleching

    The effect of concentration of bank loan rates

    Journal of Finance

    (1965, May)
  • D.R. Fraser et al.

    The structure performance relationship in banking: A dichotomous analysis

    Review of Business and Economics Research

    (1975, Fall)
  • R.A. Gilbert

    Bank market structure and competition

    Journal of Money, Credit and Banking

    (1984)
  • T. Gillini et al.

    Scale and scope economics in the multi-product banking firm

    Journal of Monetary Economics

    (1984)
  • D. Guzrarti

    Basic econometrics

    (1995)
  • T.J. Hannan

    Bank profitability and the threat of entry

    Journal of Bank Research

    (1991, Summer)
  • Cited by (29)

    • Other people's money: The profit performance of Bangladeshi family dominated banks

      2019, Journal of Behavioral and Experimental Finance
      Citation Excerpt :

      Thus, in keeping with Ahamed (2012) we find some support for the SCP hypothesis for Bangladesh banks. In contrast to Samad (2008), we find no support for the ESF hypothesis. The efficiency variable is positive but not statistically significant which means that our results do not provide any strong evidence that can distinguish between the ESF and the RMP hypothesis.

    • The impacts of risk and competition on bank profitability in China

      2016, Journal of International Financial Markets, Institutions and Money
      Citation Excerpt :

      In other words, this hypothesis suggests that lower competition resulting from higher concentration in the market leads to market power, which enables firms to earn monopolistic or abnormal profit. There are a number of pieces of research providing support to the SCP hypothesis, and the research is undertaken by Rose and Fraser (1976), Heggestad and Mingo (1977), Berger and Hannan (1989), Lloyd-Williams et al. (1994); and Samad (2008), among others. Moreover, Gilbert (1984) conducted a survey and provided a summary of 44 studies with regards to the relationship between market concentration and bank performance.

    View all citing articles on Scopus
    View full text