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Competition and Performance in Uganda's Banking System

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  • Adam Mugume
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    Abstract

    By using the non-structural models of competitive behaviour—the Panzar-Rosse model—the study measures competition and emphasizes the competitive conduct of banks without using explicit information about the structure of the market. Estimations indicate monopolistic competition, competition being weaker in 1995–1999 compared with 2000–2005. Moreover, the relationship between competition, measuring conduct, and concentration measuring the market structure, is negative and statistically significant; which could suggest that a few large banks can restrict competition. Overall, the results suggest that while competition in the Ugandan banking sector falls within a range of estimates for comparator markets, it tends to be on the weaker side. The structural approach to model competition includes the structure-conductperformance(SCP) paradigm and the efficiency hypothesis. Using the SCP framework, we investigate whether a highly concentrated market causes collusive behaviour among larger banks resulting in superior market performance; whereas under the efficiency hypothesis we test whether it is the efficiency of larger banks that makes for enhanced performance. Using Granger causation test, we establish that the efficiency Granger causes concentration and using instrumental variable approach, the study establishes that market power and concentration as measured by market share and Herfindahl index, respectively, positively affect bank profitability. In addition, bank efficiency also affects bank profitability. Other factors that affect bank profitability include operational costs, taxation and core capital requirement. A major policy implication derived from this analysis is that the Ugandan banking system has been subject to deep structural transformation since the early 1990s. Advances in information technology, liberalization of international capital movement, consolidation and privatization have permitted economies of scale in the production and distribution of services and increased risk diversification. These forces have led to lower costs and, undoubtedly, higher efficiency. However, to ensure that lower costs are passed through to households and firms, greater efficiency must be accompanied by a similar strengthening in the competitive environment in the banking sector.

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    Bibliographic Info

    Paper provided by African Economic Research Consortium in its series Research Papers with number RP_203.

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    Length: 68 pages
    Date of creation: Nov 2010
    Date of revision:
    Handle: RePEc:aer:rpaper:rp_203

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