Date of Award

5-2003

Degree Type

Dissertation

Degree Name

Doctor of Philosophy

Major

Business Administration

Major Professor

George C. Philippatos

Committee Members

Ronald E. Shrieves, M. Cary Collins, Hui Chang

Abstract

This study attempts to analyze the effects of financial liberalization and deregulation on competitive conditions in the banking industries of fourteen Central and Eastern European (CEE) transition economies using firm-level data for the period 1993-2000. The basis for the evaluation of competitive situation is the extant oligopoly theory in the new industrial organization literature, specifically, the competition model developed by Rosse and Panzar (1977), and Panzar and Rosse (1982,1987). This approach relies on the premise that, in their long-run equilibrium, banks will employ different pricing strategies in response to a change in input costs depending on the market structure in which they operate.

The results of the competition analysis suggest that the banking markets of CEE countries cannot be characterized by the bipolar cases of either perfect competition or monopoly over 1993-2000 except for FYR of Macedonia and Slovakia. That is, banks earned their revenues as if operating under conditions of monopolistic competition in that period. Overall, large banks in transition countries operate in a relatively more competitive environment compared to small banks, or in other words, competition is lower in local markets compared to national and international markets. Finally, the cross-sectional analysis of competitive structure shows initially a decreasing trend between 1993 and 1996 and a subsequent increasing trend in competitive conditions after 1996.

Having determined the degree of competition, this study further examines the relationship between competition, concentration and bank performance. The result of the empirical analysis does not yield any significant relationship between competition and concentration, suggesting the possibility that higher contestability, in part due to the recent technological advances, have resulted in an overall increase in competition, despite high level of market concentration. Furthermore, I find that the average bank deviates substantially from the best-practice frontier. The managerial inefficiencies in CEE banking markets were found to be significant, with average cost efficiency levels of 72 and 76 percent by the "Distribution-free Analysis" (DFA) and the "Stochastic Frontier Analysis" (SFA). These average estimates suggest that an average bank would have incurred 28 to 24 percent less of its actual costs had it matched its performance with the best-practiced bank. The alternative profit efficiency levels are found to be significantly lower relative to cost efficiency. According to SFA, approximately one-third of banks’ profits are lost to inefficiency, and almost one-half according to the DFA.

In explaining the cross-sectional determinants of efficiency, the results suggest that higher efficiency levels are associated with larger banks, higher profitability and better capitalization. Banks that heavily rely on core deposits in funding their assets are found to be more efficient. Consistent with most prior research, higher level of problem loans is associated with lower efficiency levels. Regarding the effect of market structure on bank performance, the level of competition is found to increase efficiency while market concentration is negatively linked to efficiency. Finally, foreign banks operating in transition countries are found to be more cost efficient but less profit efficient relative to domestically owned private banks and state-owned banks.

Overall, findings of competition analyses are consistent with previous research on competitive conditions in the banking industries of developed countries that generally report varying degrees of monopolistic competition. The notion that high concentration in CEE banking markets will result in monopoly rents as suggested by SCP paradigm is not supported by empirical results. These results seem to be compatible with contestable markets theory (CMT), if one can assume that incumbent firms set their prices close to the competitive level because of potential competition; otherwise higher prices will attract potential entrants with hit-and-run strategies. These results are also consistent with the expectation that liberalization and deregulation of CEE financial markets have increased the competitive conditions in CEE banking markets.

Recommendations for transition strategies for government efforts in designing and implementing transition program are provided as well as avenues for future research.

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