Abstract
Banks in India have been gone through structural changes in the last three decades. The prices that bank charge depend on the competitive levels in the banking sector and the risk the assets and liabilities carry in banks’ balance sheet. The traditional Lerner Index indicates competitive levels. However, this measure does not account for the risk, and this study introduces a risk-adjusted Lerner Index for evaluating competition in Indian banking for the period 1996 to 2016. The market power estimated through the adjusted Lerner Index has been declining since 1996, which indicates an improvement in competitive condition for the overall period. Further, as indicated by risk-adjusted Lerner Index, the Indian banking system exerts much less market power and hence are more competitive contrary to what is suggested by traditional Lerner index.
Highlights
Market structure, market power, and competition have been independent fields of research in both theoretical and empirical literature
A structural approach for measuring competition is based on the Structure Conduct Performance (SCP) paradigm that frames a causal relationship between market structure and pricing behavior of firms
We examine the degree of market power in the Indian banking sector post the financial sector reforms
Summary
Market power, and competition have been independent fields of research in both theoretical and empirical literature. While theoretical studies in the extant literature primarily focused on discovering novel measures of market structure, power, and efficiency, empirical research concentrated on testing the efficacy of various measures in assessing the degree of competition, in the banking sector. This study, proposes a new risk-adjusted Lerner Index to look at the competitive structure in the Indian banking sector. This study estimates the degree of market power in the Indian banking sector by proposing a Lerner Index which is adjusted for risk. By assessing market power which is adjusted for risk, this study provides policymakers an insight into the effect of risk on the market power as there is a considerable shift in the market power index This would help in designing policies for social welfare, easier entry norms, management of risk, and balanced development of the banking system.
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