A new approach to measuring competition in the loan markets of the euro area

Abstract

This article is the first that applies a new measure of competition, the Boone indicator, to the banking industry. This approach is able to measure competition of bank market segments, such as the loan market, whereas many well-known measures of competition can consider the entire banking market only. Like most other model-based measures, this approach ignores differences in bank product quality and design, as well as the attractiveness of innovations. We measure competition on the lending markets in the five major EU countries as well as, for comparison, the UK, the US and Japan. Our findings indicate that over the period 1994–2004 the US had the most competitive loan market, whereas overall loan markets in Germany and Spain were among the best competitive in the EU. The Netherlands occupied a more intermediate position, whereas in Italy competition declined significantly over time. The French, Japanese and UK loan markets were generally less competitive.

Acknowledgements

The authors are grateful to unknown referees, Francesco Drudi and participants of the Eurobanking Conference, Dubrovnik (May 2006), the XV International Tor Vergata Conference on ‘Money, Finance and Growth’, Rome (December 2006), the NBER Japan Meeting (June 2007) and seminars at DNB, ECB and BdE for valuable comments and suggestions. The views expressed in this article are personal and do not necessarily reflect those of the ECB, CPB, DNB or BdE.

Notes

¹ However, as is stressed by Allen et al. (2001), there is a conflict between this traditional view, stemming from the industrial organization literature, and more recent theoretical models of bank competition, which raise the question whether competition between banks is good or bad. See, for example, Cetorelli and Strahan (2006).

² Boone has applied his indicator to various manufacturing industries and Bikker and van Leuvensteijn (2008) to the life insurance business.

³ A world-wide study by Claessens and Laeven (2004) found that bank concentration was positively instead of negatively related to competition.

⁴ Bikker and Bos (2005), pp. 22–23.

⁵ The Lerner index derives from the monopolists profit maximization condition as price minus marginal cost, divided by price. The monopolist maximizes profits when the Lerner index is equal to the inverse price elasticity of market demand. Under perfect competition, the Lerner index is zero (market demand is infinitely elastic), in monopoly it approaches one for positive nonzero marginal cost. The Lerner index can be derived for intermediary cases as well. For a discussion see Church and Ware (2000).

⁶ This interpretation would be different in a market numbering only a few firms. Furthermore, this interpretation would also change when many new entries incur unfavourable scale effects during the initial phase of their growth path.

⁷ The few existing empirical studies based on the Boone indicator have all used a log linear relationship. See, for example, Bikker and van Leuvensteijn (2008).

⁸ The restrictions are imposed on Equation 5 so that the equation is reformulated in terms of a lower number of parameters (see van Leuvensteijn et al., 2007).

⁹ For Germany, the 1-, 2- or 3-year lagged values of the average costs are used.

¹⁰ In this article, ‘significant’ refers to the 95% level of confidence all along.

¹¹ An alternative explanation is that competition on quality may lead to both higher marginal costs and higher market shares.

¹² Savings banks have small market shares and mutually similar marginal costs, so that the overall Boone indicator is determined mainly by the few commercial banks with large market shares and varying marginal cost.

¹³ See for example Standard & Poor's (S&P, 2004) and Moody's Investors Service (2006). Our results are in line with Maudos et al. (2002), who find that profit margins during that decade declined significantly in Spain, especially for commercial banks and, to a lesser extent, for savings banks. For Italy, Coccorese (2005) presents evidence for the largest eight Italian banks during 1988–2000 that despite increased concentration the degree of competition remained considerable. Agostino et al. (2005), find high concentrations of ownership and related profit persistency.

¹⁴ In 2005 and 2006, a new wave of consolidation in the Italian banking sector was initiated. However, as our sample ends in 2004, our results do not capture these events.

¹⁵ See for example Moody's Investors Service (2005a).

¹⁶ Our results are in line with other empirical investigations, such as on competition in the Dutch market for revolving consumer credit, which showed that this market is competitive indeed (see Toolsema, 2002).

¹⁷ See for overviews of the various legislative changes for example Cetorelli (2001), Clarke (2004) and Fitch Ratings (2005). Emmons and Schmid (2000) find evidence that even before most of this new legislation was enacted, banks and credit unions competed directly.

¹⁸ The Wald test rejects the null hypothesis of no change at the 1% level of significance.

¹⁹ The UK has over 100 mortgage lenders. See also Moody's Investors Service (2005b).

²⁰ According to Heffernan (2002), the mortgage market in the UK is relatively competitive, but in other market segments such as personal loans there is substantially less competition. Results for the UK of estimations using a sample, in which the mortgage lenders are excluded, can be obtained from the authors upon request.