Measuring corporate diversity in financial services: a diversity index

ABSTRACT

This paper provides a measure of corporate diversity in financial services. Our index is based on four components: ownership; competitiveness; balance sheet structure/resilience; and geographic spread. The first of these sub-indexes measures ownership diversity based on the Berry index of diversification and the Gini-Simpson index of biodiversity. It captures the extent of diversity in ownership types – for the UK, banks, mutuals, and the government owned National Savings & Investment – where each of these have different objectives, creating diversity in behaviour. Our second sub-index captures the extent of competition, and is based on the inverse of the Hirschmann-Herfindahl index of concentration. Our third sub-index measures diversity in balance sheet structures and resilience across the financial sector. Our final sub-index captures the extent of geographic spread and the regional concentration of financial services. These indicators are combined into a single index – the D-Index – that measures diversity in financial services. The D-Index shows a marked decline in the run-up to the 2007–2009 financial crisis, followed by further falls during 2008 and 2009. Since then, the index has remained more or less flat. We are no closer to creating the conditions – of diversity – to avoid a repeat of the 2007-2009 global financial crisis.

KEYWORDS:

• Financial services
• corporate diversity
• diversity index
• financial stability

JEL CLASSIFICATION:

• G
• G2
• G3
• L1
• L2
• L3

Acknowledgements

An expert group was convened to discuss the methodology used, and we are grateful to those who contributed to that discussion at SOAS, University of London, namely, Bob Pannell (Council of Mortgage Lenders), Joanna Fitch (Banking Reform, Department of Business Innovation and Skills), Andrew Gall (Economist, Building Societies Association), Professor Laurence Harris (SOAS, University of London), Graham Hunt (HM Treasury), Professor David T. Llewellyn (Professor of Banking and Finance, University of Loughborough), and Brian Morris (Building Societies Association). Additional advice was provided by Adrian Coles, Director-General of the Building Societies Association and Peter Hunt, Chief Executive of Mutuo. We are grateful to the Building Societies Association for sponsoring the research and in particular for expert advice from their Economist, Andrew Gall. We are also indebted to Pasquale Scaramozzino for valuable comments, especially on the econometric model.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Correction Statement

This article has been republished with minor changes. These changes do not impact the academic content of the article.

Notes

1. See for example, Michie and Llewellyn (2010), and the EU.

2. Data from the BRES database. Note that this comparison spans changes in the definition of the monetary intermediation sector, which makes inter-temporal comparisons difficult. However, the effect of changes in the classification is likely to be around half a percentage point.

3. The original version of the Diversity Index (D-Index) was published in Michie and Oughton (2013).

4. While this index is commonly referred to as the Berry Index of Diversification, it appears to have been proposed independently by Berry (1971) and McVey (1972) – see Gollop and Monahan (1991). The index is in fact identical in structure to the Gini-Simpson index discussed below and first developed by Simpson in 1949. In his book, Berry (1971) states that he has derived the index as an application of the Herfindahl index of concentration and appears to be unaware of the earlier work by Hirschman (1945) or Simpson (1949).

5. In the case of a uni-product firm the index would be equal to zero, in the case of a multi-product firm with production spread evenly over a very large number of products, the index would approach 1.

6. This index is similar to the Hirschman-Herfindahl index of concentration first introduced by Hirschman in 1945 (as an index of trade concentration across different commodities using the square root of the above formula) and subsequently developed by Herfindahl in 1950 as an index of market concentration using the above equation based on each firm’s market share in the steel industry.

7. Edmonds, Jarrett, and Woodhouse (2010) provide a useful timeline of the events of the credit crisis.

8. The mutual sector was gradually increasing its share of deposits prior to the 2007–2009 international financial crisis.

9. These spreads are shown in Appendix 2, Chart 2 along with our corporate diversity index for mortgages. The data end in 2007 when the Bank of England stopped publishing separate interest rate figures for banks and building societies. The correlation coefficient between the banks’ Mortgage Rate-Deposit Rate spread and our corporate diversity index for mortgages is −0.9 and is statistically significant at the 0.01% level (99% confidence interval).

10. The lower bound of the index is close to zero for competitive markets with a large number of firms with equal shares, since as the number of firms increases 5/n approaches zero.

11. Hart (1975) argued that the HH index is more sensitive than CR5 to changes in the number of firms (n); however, Davies (1979) has subsequently shown that it is less sensitive to n except at very low levels of concentration.

12. Note that the OFT calculates the HH index in terms of percentage market shares and so these thresholds become 1000 and 2000 respectively, i.e. the raw index is effectively multiplied by 100 × 100 = 10,000.

13. This measure is used by the Bank of England in its Financial Stability Reports as a measure of banking sector resilience, see Bank of England (2010), Bank of England (2012).

14. Note that small lenders without UK retail deposits (for example, Kensington and Britannic Money, who entered the top 30 mortgage lenders in 2002 and Lehman Bros, who entered in 2004) are excluded from this analysis so that Chart 3 shows the upward drift in funding models used by retail deposit taking institutions. Inclusion of the likes of Kensington et al would shift the maximum value to 1 from 2002 onwards. Northern Rock and Bradford and Bingley are included under UKAR in 2010 and 2011.

15. Lenders without UK deposits were excluded, as their loan to deposit ratios are undefined.

16. The Corporate Diversity Index (CD), the Competitiveness Index (CI) the Geographic Spread Index (GS) and the D-Index may be measured for the mortgage and deposit markets individually as shown in Figures 1, 2, 6 and 7 or combined by taking the average across the mortgage and deposit markets to give a composite index for the retail financial sector.

17. The Bank of England stopped publishing separate data for banks and building societies in 2007 so these are the most recent data available.

18. The data series end in December 2007 as the Bank of England ceased publication of separate interest rate data for Banks and Building Societies from January 2008 onwards.

19. O’Connor (2010) argues that the decision to change the way in which the Bank of England and the National Statistics Office classified different types of monetary and financial institutions was associated with, or prompted by three factors: the relative importance of Building Societies and banks; disclosure issues; and the change in the BSA’s data coverage.

Additional information

Funding

The work was supported by the Building Societies Association.