Reevaluation of the market structure performance relationship for banks under different regimes

Abstract

Both industrial organization and banking literature frequently find a positive statistical relationship between profitability and its market structure. A theory of relative market power hypothesis asserts that firms with large market shares and well-differentiated products are able to exercise market power in pricing in these products and earn supernormal profits. On the other hand, a theory of efficient structure hypothesis states that efficient firms increase in size and market shares because of their ability to generate higher profits, which usually leads to higher market shares or concentration. Previous empirical tests of these hypotheses have yielded mixed results but the tests were not robust because they did not incorporate measures of efficiency directly in the model. Also, an important determinant of bank performance that may be caused by different regulations or supervision has not been discussed in banking literature. This paper uses the test developed in Berger (1995) followed by Berger and Hannan (1997) and Goldburg and Rai ( 1996) to reexamine the structure performance relationship for banks in different regimes, separated banking versus universal banking system. The evidence reveals that, in general, more efficient banks gain higher market shares and earn greater profitability that is supported by our data through the efficient structure hypothesis. Therefore, antitrust application in both system is not warranted, since increased market shares through mergers and acquisitions does not relate the theory of relative market power hypothesis.