Contestable markets theory, competition, and the U.S. commercial banking industry

This study uses Contestable Markets Theory (GMT) to examine commercial banks in the United States. The first part of the study examines changes in net earnings for individual products of U.S. commercial banks for the years 1973-1988. Data are obtained from the Federal Reserve System's Functional Cost Analysis program. This period is of particular interest because of the regulatory changes and product innovations that allowed other financial institutions to compete directly with commercial banks, thus providing a period to compare actual changes in net earnings with those expected by CMT. Empirical results are consistent with imperfectly contestable markets, especially for credit card and instalment loans and personal and interest-bearing checkable deposits. The second part of the study uses accounting and market information from the same 1973-1988 period for all banking firms on the CRSP NYSE/AMEX and OTC tapes with sufficient data to calculate excess market value, an approximation to Tobin's q, and systematic risk (measured by β). These measurements examine contestability at the firm level and generally do not show support for contestability.