Market power versus efficiency under uncertainty: conventional versus Islamic banking in the GCC

Abstract

In this article we estimate the effect of concentration on intermediation margins in Gulf Cooperation Council's (GCC) Islamic and conventional banking under the assumption that margins are uncertain. The empirical model, which we formally derive from an expected utility maximization problem, allows us to test for risk aversion as well as competitive conduct in loan and the deposit markets. The model also yields an expression showing that the effect of concentration on margins is the sum of its respective effects on market power, marginal cost of intermediation and marginal cost of uncertainty. The expression allows us to test whether concentration is welfare enhancing, reducing or neutral. We find Islamic banks to be risk-averse and conventional banks to be risk-neutral. We also find that concentration is welfare-neutral in Islamic loans and deposits, welfare-enhancing in conventional loans and welfare-neutral in conventional deposits. We used Nonlinear Two-Stage Least Squares (N2SLS) and Nonlinear Three-Stage Least Squares (N3SLS) to check for robustness.