A Literature Review on the Determinants and Measures of Competition in Banking Sector - Economicus

by, Zerina bruci, Dr. Anilda Bozdo

Abstract

The level of competition in the banking sector is important to the performance of the sector and has different implications in other key markets in the economy. Competition in the banking sector is extremely important because of the central role that banks have in (1) welfare enhancing for consumers and businesses, (2) the transmission of monetary policy and (3)the maintenance of financial stability. The complexity of the notion of competition and its importance for the overall economic development has led to the development of different models and measures to assess its level in the banking sector. The literature offers two main approaches: (1) The Structural approach based on the Traditional Industrial Organization theory and (2) the Non-Structural approach based on the New Empirical Industrial Organization theory. The non-structural approach determines the level of competition based on the market structure; while the non-structural approach infers the competition degree based on the behavior of the banks in the market. This paper presents some of the widely-applied methods in assessing the level of competition in the banking sector, such as Lerner Index, Panzar-Rose Methodology, Boone Indicator etc, and identifies their strengths and weaknesses. Some of the common determinants of the level of competition in banking sectors across countries, such as market structure (bank consolidation and the introduction of foreign capital), contestability of the market, level of economic development and quality of institutional framework, bank specific conditions and the liquidity preferences of banks are discussed to enable a better understanding of the concept of competition in the banking sector and what affects it. The literature on the level of competition in the Albanian Banking sector is focused in the last decades and mainly after 2003. Even though the concentration level in the Albanian banking sector is the highest in the region, the system is characterized by a moderate level of competition and performs better than some of the other countries in the region. This moderate level is in line with the literature on banking sector competition in developing countries.