Advanced Search
MyIDEAS: Login

The Efficiency Cost of Market Power in the Banking Industry: A Test of the 'Quiet Life' and Related Hypotheses

Contents:

Author Info

  • Allen Berger
  • Timothy Hannan

Abstract

Traditionally, concerns about market concentration have focused on mispricing and the restriction of output relative to competitive markets. This type of loss is typically measured by the standard welfare triangle. The associated welfare losses usually motivate antitrust policy. This paper focuses on another type of loss from concentration and market power that may be much larger. Firms that are not subject to rigorous market discipline may take some of their market power rewards not as higher profits, but as a "quiet life" in which cost efficiency suffers. Similarly, managers of firms in concentrated markets may exercise expense preference motives and worsen cost efficiency in this way. The question of whether increased concentration and market power reduces firm cost efficiency may be particularly important to policy analysis of the banking industry. The recent wave of mergers among large banking organizations, particular "horizontal" or "within-market" mergers between banking organizations situated in the same local markets raises concerns about the increase in local concentration. If the "quiet life" and related efficiency-reducing effects of concentration are substantial, they might be considered in the merger approval process along with the traditional concerns about the welfare loss due to mispricing and the safety and soundness of the consolidated enterprise. The authors estimate how bank efficiencies are affected by local market concentration, controlling for number of factors, including regions, state regulation, size, and corporate governance. The banks in the sample represent over two-thirds of all U.S. banking assets. The basic hypothesis tested is that the market power exercised by firms in concentrated markets provides a price "cushion" above the competitive level that allows firms to avoid the rigors of cost minimizing without necessarily exiting the industry. The authors' empirical application suggests that market concentration does result in significantly lower cost efficiency. Extrapolating the results to the entire U.S. banking industry, they find that the operating efficiency costs associated with market concentration appear to be several times larger than the social losses due to the noncompetitive pricing of bank outputs, as measured by the traditional "welfare triangle." The authors suggest that these results may have general implications regarding antitrust policy, and specific implications regarding regulation of the banking industry. If they hold up under further scrutiny, they suggest that antitrust and merger policy consider cost efficiency implications of impending mergers. Current Justice Department guidelines do not explicitly consider the possibility for laxity in cost controls that might be a results of increase in market power. The fact that banking mergers among banks in overlapping markets has not generally been found to improve cost efficiency could conceivably results from the efficiency costs of the higher concentration as measured here. That is, a reduction in market pressure to minimize costs may have offset the technical cost economies associated with the consolidations. These issues are important because so many regulatory issues involve changes in the degree of competition or market contestability.

Download Info

To our knowledge, this item is not available for download. To find whether it is available, there are three options:
1. Check below under "Related research" whether another version of this item is available online.
2. Check on the provider's web page whether it is in fact available.
3. Perform a search for a similarly titled item that would be available.

Bibliographic Info

Paper provided by Wharton School Center for Financial Institutions, University of Pennsylvania in its series Center for Financial Institutions Working Papers with number 94-29.

as in new window
Length:
Date of creation: Nov 1994
Date of revision:
Handle: RePEc:wop:pennin:94-29

Note: This paper is only available in hard copy
Contact details of provider:
Postal: 3301 Steinberg Hall-Dietrich Hall, 3620 Locust Walk, Philadelphia, PA 19104.6367
Phone: 215.898.1279
Fax: 215.573.8757
Email:
Web page: http://fic.wharton.upenn.edu/fic/
More information through EDIRC

Related research

Keywords:

Other versions of this item:

References

No references listed on IDEAS
You can help add them by filling out this form.

Citations

Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
as in new window

Cited by:
This item has more than 25 citations. To prevent cluttering this page, these citations are listed on a separate page.

Lists

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

Statistics

Access and download statistics

Corrections

When requesting a correction, please mention this item's handle: RePEc:wop:pennin:94-29. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Thomas Krichel).

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.