Market concentration and pricing behaviour of Sri Lankan banks

Abstract

PurposeThe purpose of this paper is to investigate whether the level of market concentration in Sri Lanka's banking sector is positively associated with bank‐specific interest spreads after controlling for other bank‐specific and exogenous influences.Design/methodology/approachA pooled, time‐series and cross‐section model is utilized which distinguishes between banks’ dominance in loan and deposit market segments. Results are presented for the total sample as well as for a truncated sample of private‐owned banks.FindingsChanges in industry concentration do not affect bank‐level interest margins of Sri Lankan banks. Nevertheless, the dominant Sri Lankan banks seem to extract them and banks’ cost structures are priced in their interest spreads. The less‐capitalized, high risk banks operate with narrow interest margins, possibly due to the relatively higher deposit rates they pay to attract deposits. Although regulatory changes seem to have no effect, the growing capital market exerts negative pricing pressure on Sri Lankan banks.Practical implicationsThe regulators should closely watch banks with larger loan and deposit market shares because they seem to exploit their dominant presence and geographical reach to extract higher spreads. Similarly, state‐owned banks should also draw regulatory attention for they extract higher interest margins, possibly, in lieu of their high operational inefficiency levels.Originality/valueThe authors employ an extended time‐series and cross‐section model which controls for sample heterogeneity using proxies for cost structures, risk profiles, regulatory restrictions and other environmental influences. Moreover, as far as it could be ascertained, this is the first such study on Sri Lanka's banking sector.