Switching costs and bank competition: Evidence from dual banking economies

Abstract

There is a strong theoretical foundation that demonstrates costs of switching as one of the main barriers in creating a healthy level of competition. Switching costs might even be more prevalent for Islamic banks due to Shariah dimension since Shariah driven customers are limited to only switch to banks that offer Shariah-compliant products. However, the banking market is not completely segmented as Islamic banking clients can switch to conventional banks, and vice versa. This paper examines the degree of switching costs in Islamic and conventional banks, and investigates its influence on bank competition in dual banking economies. We find that conventional banks inherit higher switching costs than Islamic banks. The finding is consistent for all countries in the sample except for Malaysia and Bahrain. We also find that switching costs during the global financial crisis are higher than the rest of the years. We further document a significant negative relationship between switching costs and bank competition, while this relationship is more pronounced for Islamic banks.