Abstract
The banking sector of Pakistan has witnessed a notable transformation in its structure and business activities following the implementation of financial sector reforms since the early 1990s. Specifically, the reforms helped transform a repressed financial sector into a market oriented and sound financial sector, predominantly owned and managed by the private sector. How these developments have impacted competition among the banks is still an open question. This study attempts to answer this question with the application of a new approach to measure competition: Boone Indicator of competitiveness. This measure postulates that inefficient firms (banks) in a competitive environment are punished harshly, and there is an output reallocation from inefficient to efficient firms/banks. We have estimated elasticity of market share to marginal costs for 24 banks in Pakistan, using a balanced panel of bank level (annual) data for the year 1996 to 2015. Marginal costs are obtained indirectly by first estimating a translog cost function using earning assets as an output, and cost of financial capital, physical capital and labor as inputs. The estimated Boone Indicator value of negative 0.31 is significant and suggests that inefficient banks have been losing their market share to efficient banks over the estimation period: a reflection of underlying competitive environment. Increasing value of Boone Indicator (in absolute terms) over the period of study suggests that competition among the banks in Pakistan has increased over time.
Highlights
Operating environment for banks in Pakistan has witnessed substantial changes since the implementation of financial sector reforms in early 1990s
This paper investigates competition in the banking sector of Pakistan by using a recent approach, popularly known as Boone Indicator
This approach is based on the intuition that inefficient firms are punished harshly in competitive markets, which leads to reallocation of output from inefficient to efficient firms
Summary
Operating environment for banks in Pakistan has witnessed substantial changes since the implementation of financial sector reforms in early 1990s. Privatization of state owned commercial banks was initiated, and private sector was encouraged to open new banks; directed credit schemes were gradually discontinued; cap on lending rate was abolished; branch licensing policy was liberalized; and use of information technology for the provision of financial services was facilitated. State Bank of Pakistan (SBP) has been actively facilitating Islamic banking, branchless operations, and micro financing, to promote access to financial services. All these changes were designed to instill a healthy competition, and create a sound and an efficient banking system capable of supporting the growing economic activity. Developments have led to significant changes in the structure of the banking sector in Pakistan: the share of big 5 banks has declined from over 90 percent in early 1990s to 51.5 percent by end 2015; the ownership structure has changed from the public to the private sector
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