Indian Banking Industry Competitiveness and Market Structure

Indian Banking Industry Competitiveness and Market StructureIntroductionAfter 1991 crisis, Indias liberalisation journey was multi-faceted. One of the education aras of liberalization was the banking sector which was highly regulated and controlled by government. Most importantly for banking industry, as per the M. Narasimhan committee recommendations, the liberalization came in the right areas namely interest rate, step-down of reserve wants, entry deregulation, credit policies and prudential supervision.Incase of interest rates, they could now be determined by the banks based on their cost of funds quite then government fixing them for banks. The administered regime for interest rate came to an end except for interest rate on savings account. The reduction of reserve requirement for banks made huge capital available for banks which could be deployed in the business. The entry of new players was de-regulated. The government empowered the Reserve Bank of India to issue license s to the new players, if they met the destine criteria jointly set by RBI and Finance Ministry. The credit balancening was completely done away with. Although there is still credit proportionalityning for precedency sector, the banks are free to deploy their capital on the sectors which they feel profitable. Excessive supervision regime came to an end. The Reserve Bank of India made several changes in prudential supervision and gave autonomy to banks in their day-to-day operation.The centre asset size of Indian Banking industry is over US$ 270 billion. The total deposit amount is US$ 200 billion. Its branch network is one of the largest in the world with more than than 66,000 branches and over 17,000 ATM spread across the country. The bank assets are expected to rise at 13.4% CAGR and it is predicted that India could become the 3rd largest banking hub in the world by 2040.Currently India has 80 Scheduled commercial banks out of which 28 are public sector banks, 24 private ba nks and 28 foreign banks (Annual Report, RBI). As Indian economy is growing at an average rate of over 7% since a decade, more and more foreign banks are thinking to foray into the Indian food market. As per McKinseys report on Indian Banking (2010), total loans-to-percentage of GDP, could grow from its current level of nigh 30% to 45% in years to come. Such huge opportunities in like mannerprompts several questions Who is/ are the dominant players in the market? What is/are their share in the banking industry? What is the market social system of Indian banking industry is it a monopoly or a perfect competition?Objectives and MotivationThe objective of this dissertation is to understand the Indian banking industry, its composition (nationalised banks, private bank and foreign banks) and knowing the players of the industry.Further the study will find out how much concentrated the Indian banking industry is and fork over knowledge regarding bakshis 3 as well as top 5 major banks . Such a assiduity ratio would give a fair idea of how end of the top players as an implication on the former(a) industry players.The study will include the determination of the market social system of Indian banking industry. Its imperative to know whether the industry is a perfect competition, a monopoly or a monopolistic competition. This would lead to understanding of the cohesive behaviour of the market players.My motivation for choosing this topic came from the complexity of the Indian banking industry. The number of players, entry of new players, consolidation among the existing players, ever-changing economic scenario of India etc and its impact on the banking industry perpetually fascinated me to do a study on the Indian Banking industry. I also feel that such study would be useful not entirely for the policymakers within the central bank and the government but also for the existing players, the potential entrants and for other stakeholders of the banking industry.Lite rature ReviewAs per the neoclassical theory, the spectrum of market expression can be defined by the number of firms and size of those firms in the market Goddard, Molyneux Wilson (2001). Various numerical measures of concentration have been used by semiempirical researchers in allege to find the concentration of industry players. But at the same time, there is no single perfect measure for concentration Goddard, Molyneux Wilson (2001). all the same all these measure are subject to the idiosyncracies and limitation they usually tend to correlate highly with each other Curry and George (1983) Scherer and Ross (1990).Hall and Tideman (1967) have provided the desirable properties which are required for these measures of concentration to be acceptable.Concentration measures like k-bank concentration ratio, Herfindahl-Hirschman superpower (HHI) are extensively used to measure the banking sector performance as a function of market structure Barth et al., 2004, Beck at el, 2006).k-b ank concentration ratioFor measuring the concentration of firms, the most frequently used ratio is k-bank concentration ratio (Bikker 2004). The flat coat this ratio is so frequently used is because of its simplicity and limited data requirement. The index gives equal emphasis to the k leading banks, but neglects the many exquisite banks in the market. It is a one dimensional measure ranging between zero and unity Al-Muharrami S.,Matthews k., Khabari Y (2006). In a review of 73 US Structure-Conduct-Performance studies in banking from 1961 to 1991, in 37 studies the k-bank deposit concentration measure was used (Molyneux et al. 1996)Herfindahl Hirschman Index (HHI)HHI is another benchmark measure for measuring the bank concentration and gives more pitch to larger banks. It was developed by A.O.Hirschman. It expands to all the banks in the system, thereby avoiding the arbitrary cut offs Alegria, C and Schaeck K (2006). Bikker (2004) highlights the importance of HHI in the theoretic al research. In practice, the HHI plays a pivotal role in the US for the approval of bank mergers where the post mergers market HHI cannot exceed 0.18 and that the change in the index should be less than 0.02 (Cetorelli, 1999).This index is also used to measure the bank concentration in Arab GCC banking system Al-Muharrami S.,Matthews k., Khabari Y (2006) and in measuring the competition and market structure in the Saudi Arabia Al-Muharrami (2009)Panzer and Rosse H statisticsThe measure of market structure serves in determining whether the market enjoys perfect competition, monopoly or monopolistic competition. This is also known measuring the monopoly power hypothesis. It meat that in more concentrated markets the bigger players tend to be collusive and try to dominate the market. Also their actions have considerable impact on the other market players.There are several models for determining the market structure. The models are divided into two parts 1) Structural Models and 2) Non Structural Models.This study will habituate the non-structural model approach suggested by Rosse and Panzer (1977) and Panzer and Rosse (1982, 1987), popularly known as the H-statistics. It is widely used in determining the competitive structure of the banking industry in variant countries.In the banking industry, there is extensive use of Rosse and Panzer method and has got a wide practical applicability. In his study on New York banks, Shaffer (1982) had observed that banks had monopolistic competition. alike study for Canadian banks by Nathan and Neave (1989) found a perfect competition for 1982 but monopolistic competition for 1983-84. Japan revealed perfect competition Molyneux et al (1996).Molyneux et al. (1994) also tested the P-R statistics for French, German, Italian, Spanish and British banks for the period of 1986-1989 in order to determine the competitive conditions of major European countries.MethodologyThe study involves the use of k-bank concentration ratio and HHI ratio for gauging the competition and Panzer and Rosse for determining the monopoly power of the players of Indian Banking industry. These ratios have been extensively used in the different studies mentioned above.K-bank concentration ratio measures the market share of the top k-firms in the industry. The equation isnCRn = Sii=1Where Si is the market share of the i-th firm when firms are ranked in descending order of the market share.Market share is measured in terms of sales, assets or number of employees. Commonly used cling tos of n include 3, 4, 5 or 8. The researchers have also found that there is high correlation between concentration ratios defined using alternative values of n Bailey and Boyle (1971). The advantage of k-bank concentration ratio is that it is easily measurable one needs to know only the total size of the industry and the individual sizes of firms. But it lacks in taking the size distribution of remaining firms.In this study, the market share would be me asured on the basis of the loan size (assets) and the deposit size (liability) of the banks. The value of n would be 3 and 5 i.e. CR3 and CR5.HHI uses information about all points in the firm size distribution. It is defined as the sum of the squares of the markets share of all firmsNHHI = Si2i=1Where Si is the market shares of the firm i and N is the total number of firms in the industry. In the calculation of HHI, the larger firms get a heavier weightage than their smaller counterparts which reflects their relative importance in the market.This study uses P-R h-statistics, a non-structural model, measuring competition and emphasizes the analysis of the competitive conduct of banks without explicit information about the structure of the market. The P-R determines the competitive behaviour of banks on the basis of the comparative static properties of reduced-form revenue equation based on cross-section data Panzer and Rosse (1987).The equation isLn(TREV) = 0 + 1 ln PL + 2 ln PK + 3 ln PF + 4 ln RISKASS + 5 ln ASSET + 6 ln BRThe variables are defined as followsTREV the ratio of total revenue to total assetsPL ratio of personnel expense to employeesPK ratio of capital expense to fixed assetsPF ratio of annual interest expense to total loanable fundsRISKASS ratio of provisions to total assetsASSET bank total assetsBR ratio of number of branches to total number of branches in thecountry.The H-statistic value is the sum of factor price elasticity PL, PK and PF. The value H 0 implies monopoly equilibrium. A value of 0 DataThe data for all the calculations of k-bank concentration ratio, HHI and P-R H-statistics will be obtained from Orbis database. Further, the data would also be interpreted from the Reserve Bank of India(RBI)s profile of banks 2004-2005 2008-2009. Incase any data is not available from the two main sources (Orbis and RBI), the data would be extracted from financial statements of banks, from their websites and from reports published on the In dian Stock exchanges namely Bombay Stock Exchange (BSE) and National Stock Exchange (NSE).The sample period covers 2002-2008.ConclusionThe conclusion would include the interpretation of the results obtained by usage of E-view and MS- Excel software. In summation, the study would help in knowing the concentration ratio through k-bank ratio as well as HHI and help in understanding the monopoly power of large banks in India. Such a study would be helpful to determine the cohesive behaviour of the players of industry and how their decision would affect the entire industry as well as the Indian economy. With a lots consolidation happening in the industry, such a study would help in understanding the shifts in the concentration and market powers if any.Last but not the least an attempt would be made to give more or less recommendations based on the results.