DP/01/2010 (English Version)

BANK OF THAILAND DISCUSSION PAPER

Measuring the Level of Competition in the Loan Market of the Thai Banking Industry Using the Boone Indicator
2553
E-Mail Address: rungporr@bot.or.th

Measuring the Level of Competition in the Loan Market of the Thai Banking Industry Using the Boone Indicator
Rungporn Roengpitya
April 30, 2010

Abstract
This paper follows the pioneer eort in measuring the competition level in the loan markets among selected countries in the European Union by van Leuvensteijn et al. (2007). In this study, the competition level in the loan market of the Thai banking industry is calculated both in aggregate of time and by year, from 1994-2004. In addition, for comparison purposes, I also re-assess the level of competition in the loan market of the U.S. banks, using the data from the CALL Report during the years 1994-2004, which is dierent from the original paper that uses the Bankscope data from 19992004. The results indicate that the Thai banking industry is much less competitive when compared to the U.S. banking industry and bears higher marginal costs, which consequently translates to lower eciency. Finally, it is worth noting that the method of estimating the translog cost function diverges from the EU paper in a sense that the states xed eects are included in this study and that the marginal cost equation is estimated dierently due to the use of a dierent marginal cost equation.

Risk Management Examination Division, Supervision Group, the Bank of Thailand. Email: rungporr@bot.or.th. I am extremely grateful to the pioneers of this approach at the European Central BankMichiel van Leuvensteijn, Jacob A. Bikker, Adrian A.R.J.M. van Rixtel, and Christoer Kok Srensefor their helpful support and comments. The views in this study are truly of my own and does not necessarily represent the views of the Bank of Thailand.

Introduction
This paper attempts to assess the level of competition in the loan market of the Thai banking industry in the past 15 years and comparing it to another banking industry, notably that of the United States. The results can be compared on an aggregate level (in a sense of an average of all years) and by year. In addition, the results can be extended to other countries and other types of market (such as deposits). Assessing the level of competition has important policy implications, as it is linked directly to eciency and, hence, social welfare. The results of such assessment can later be used to craft necessary policies to increase competition in a particular industry. Measuring competition has always been a challenge to many industrial organization economists. This is because a traditional measurement such as the Herndahl-Hirschmann Index (HHI) may present only a partial picture of competition. Moreover, using the price cost margin alone tends to misrepresent the development of competition over time for markets with high policy relevance where only a handful of rms exist (i.e. in a highly concentrated market) as mentioned in Boone et al. (2007). Usually, measuring the level of competition in the banking industry is made much more dicult by many reasons. The data availability on costs and prices by product-type is limited.1 Moreover, the consolidation may be encouraged in an environment where banks are over-supplied, as claimed by many to have happened in the U.S. before the Riegle-Neal Interstate Banking and Branching Eciency Act of 1994 was passed, allowing banks to merge across states for the rst time. In this latter case, looking at the HHI alone will be misleading.2 A new approach in measuring competition was introduced by Boone (2000, 2004), Boone et al. (2004) and applied to the banking industry for the rst time by van Leuvensteijn et al. (2007), who measured the level of competition in 6 European Union countries and 2 non-EU countries (the U.S. and Japan). The Boone measurement approach has many advantages. First, it is capable of providing a micro-level analysis; for example, by product type oered by banks or by types of
1 For

further details, please see van Leuvensteijn et al. (2007)

and Laeven (2004) found that bank concentration varies positively with the level of competition, contrary to the conventional belief of their negative relationship.

2 Claessens

banks (commercial, savings or cooperative banks) or by year, while the Panzar-Rosse model oers the analysis only at the aggregate level. Secondly, as mentioned in van Leuvensteijn et al. (2007), the Boone model requires very little data, compared to the Bresnahan model. However, it is worth noting that the Boone approach relies on two key assumptions which may or may not be true in a particular banking industry. 1. Banks will pass on at least part of their eciency gains to their clients 2. Banks oer the same product quality and design and possess the same attractiveness of innovations There are a few key dierences between this study and of van Leuvensteijn et al. (2007). First, the marginal cost equation is calculated a little dierently. Second, the process of estimating the translog cost function for the U.S. in this study also includes the states xed eects, which is crucial in taking out dierences between states in terms of dierent banking legislations that may have biased the estimation. Third, the periods used for the U.S. estimation is from 1994-2004,3 not 1999-2004 as previously executed, to include the deregulation eects in the U.S. banking industry during the 1990s. Finally, the data source for the U.S. used in this paper is from the CALL Report instead of the Bankscope database. I nd that, compared to the U.S., the Thai banking industry is quite a lot less competitive during the years 1994-2004, as measured by the competitiveness in the loan market. In addition, the estimation of the translog cost function (TCF) points to the fact that Thai banks bore higher costs than U.S. banks and, consequently, were operating ineciently. The paper is structured as follows. Section 1 provides the theory, the mathematical derivation and assumptions behind the regression in this study, notably the translog cost function, the marginal costs, and the Boone estimation equation. Section 2 presents the details on the data used in this study. The regressions, results and analysis will be in Section 4 and the nal remarks conclude the paper. The literature review on measuring competition is presented in van Leuvensteijn et al. (2007) and therefore omitted here.
3 The

data on securities used in this study was not available prior to 1994.

Theory, Mathematical Derivation and Assumptions

This section presents the theory, the detailed mathematical derivation and also the assumptions used to develop the translog cost function, the marginal costs and the Boone estimation equation.

1.1

The Theory

Theoretically, the Boone model relies on the notion that more ecient rms (i.e. with lower marginal costs) will possess higher market shares (and consequently prots) and this eect of eciency on market shares will be stronger in the environment where the competition is more intense. This is because an increase in competition should lead to a reallocation of output from inecient rms to more ecient rms. Although Boone has developed quite a few theoretical models for dierent kinds of markets (see Boone, 2000, 2001 and 2004, and Boone et al. 2004), van Leuvensteijn et al. (2007) relied on the Boone et al. (2004) model for their application of the theory to the banking industry. In the model, bank i will face the linear demand of product oered qi in the form p(qi , qj =i ) = a bqi d
j =i

qj

(1)

with a constant marginal cost mci . a is an intercept which can be interpreted as a price a customer is willing to pay to any bank that oers the rst unit of product q . b measures the sensitivity to price of a customer with respect to the product oered by bank i while d is the price sensitivity of a customer to the same product oered by rival banks qj =i . Note that d can also be interpreted as the measurement of the degree of substitutes of this product between banks. If d = 0, then bank i will be the only bank oered product qi and other banks products qj has no commonality to the product qi . Therefore it cannot be a substitute to qi and plays no role in the demand of qi . As d increases, the more substitutable qj is to qi . Given the remarks above, two key assumptions are imposed: 1) a > mci which means that the price of the rst unit chargeable to the customer has to exceed the marginal cost (otherwise the prot is negative from the beginning); and 2) 0 < d b, which means the products cannot be perfect substitutes. Next, assume that banks have an entry cost (xed cost) of , the objective function of 4

banks is to maximize the prot = (pi mci )qi by choosing the right level of qi from the prot function.4 The rst order condition for the Cournot-Nash equilibrium is a 2bqi d
j =i

qj mci = 0.

(2)

Without loss of generality, let there be N banks in the market of product q . The general closed form of the solution is qi (mci ) =
b b 2d 1 a 2d + N 1 mci + j

mcj

(2b + d(N 1))

b 2d

(3)

relating the output qi and marginal costs mci . The idea of Boone et al. (2004) is that competition can be enhanced through two channels through an increase in d (products become closer substitutes) and through a decrease in an entry cost . The authors showed that competition indeed reallocated output (in monetary term) from inecient rms to more ecient rms. Using the prot function = (pi mci )qi and equation (3), it can be shown that prot is a quadratic function of output, i = b[q (mci )]2 . (4)

Therefore, it can be inferred from the analysis above that a higher level of competition increases relative prots of a rm relative to a less ecient rm. Finally, the shift of output toward the more ecient rms means that, in a more competitive environment, the more ecient rms will also gain a market share. Therefore, competition will also lead to more ecient rms obtaining more market shares. Applying the Boone et al. (2004) model to the banking industry, van Leuvensteijn et al. (2007) therefore used the market share approach and estimated the Boone indicator according to the following equation (assuming there are N banks in the system), ln Si = + ln mci + ui where Si is dened as the market share of bank i for product q , Si = cost.
4 as

(5)
qi N j =1

qj

and mci is the marginal

the marginal cost is assumed constant so the total cost is just mci qi

From equation (5), it is clear that the eect of the change in the marginal cost mci on the market share Si can be measured by , which is called the Boone indicator. Using the analysis above, should be such that < 0, since more ecient rms (with lower marginal costs) should have more market shares and the eect (| |) will be stronger in a more competitive environment. Finally, it is worth noting that applying the Boone indicator concept to the banking industry requires additional assumptions listed in the introduction section. The passing-of-prot behavior is to ensure that banks behave quite the same when it comes to choosing between having higher prots or lowering output prices if the marginal costs decrease. The second assumption has the purpose of making sure that competition is important enough for banks and they will innovate from the peer pressure.

1.2

Mathematical Derivation

Given equation (5), there are two variables we should consider in estimating the Boone indicatorthe market share Si and the marginal cost mci . The data on the products oered by banks (such as loans, deposits, etc.) in a banking industry is commonly available. Calculating the marginal cost is proved to be much trickier. Generally, the marginal costs can be approximated by the average variable costs. This approach has a downside in a sense that, theoretically, the marginal costs will equal the average variable costs only if the average variable costs are at the minimum. Therefore, van Leuvensteijn et al. (2007) chose to estimate the marginal costs using the translog cost function (TCF) for a particular product oered by banks.5 A TCF is a second-order Taylor expansion around the mean of a typical dual cost function with variables in the natural logarithmic forms.
H 1 h ln Cit T 1 H K

= 0 +
h=1 H K

h dh i +
t=1 K

t d t +
h=1 j =1

jh ln xijt dh i

+
h=1 j =1 k=1

jkh ln xijt ln xikt dh i + vit

(6)

h where Cit is the production costs of bank i, i = 1...N of type h (commercial, savings or cooperative
5 The authors chose this functional form because it is a exible functional form that has proved to be an eective tool in explaining multiproduct bank services.

banks) in year t, t = 1...T . 0 is an intercept while dh i and dt are the dummies for bank types and years respectively. The explanatory variables xijt can be grouped into two categoriesoutput components and input components. There are three output componentsloans, securities, and other services. Three input prices include wage rates, funding rates and other expenses. The output components enter the equation as an amount while the input prices enter the equation as a rate or have been normalized to be a share of some sort. Without loss of generality, I dene j = 1, ..., K and k = 1, ..., K in the following way.

j j j j j j

=k =k =k =k =k =k

=1 =2 =3 =4 =5 =6

for for for for for for

the wage rates (variable name wage) the funding rates (variable name fund) the other expenses (variable name othexp) loans (variable name loans) securities (variable name sec) other services (variable name othserv).

Moreover, additional restrictions are imposed on the coecients of the TCF

1 + 2 + 3 1,k + 2,k + 3,k k,1 + k,2 + k,3 j,k

= = =

1 0, 0, k = 1, 2, 3 k = 4, 5, 6 j, k = 1, ..., K.

(7) (8) (9) (10)

= k,j

The rst and second conditions indicate the assumption of the linear homogeneity in the input prices, which means that three linear input price elasticities (i , i = 1, 2, 3) add up to 1, whereas the squared and cross terms of all explanatory variables (i,j ) add up to zero. The last condition in equation (10) is the symmetry restriction such that j,k = k,j for j, k = 1, .., K . To estimate the translog cost function more accurately, the ratio of total equity to total assets and its squared term are added to control for dierences in loan portfolio risk across banks (Berger and Mester (1997)). The appendix provides the TCF equation used in the estimation of the translog cost function in detail.

Using the general denition of marginal costs, the marginal cost for loans (j=4) is dened by mci4t = Ci4t Ci4t ln Ci4t = . xi4t xi4t ln xi4t (11)

where Ci4t is the total cost and xi4t is the amount of loan issued by bank i in year t and j = 4 denotes the product for loans, using the denition on page 7. The second equality comes from applying the logarithmic rule
ln Ci4t ln xi4t

1 Ci4t 1 xi4t

Ci4t xi4t

. by dierentiating the TCF in equation (6) with respect to

We can calculate the term

ln Ci4t ln xi4t

ln xi4t for each type h of banks (and the superscript h is removed) and applying the symmetry j,k = k,j . Therefore, ln Ci4t ln xi4t = 4 + 244 ln xi4t +
k=4

4k ln xi4t +
j =4

j 4 ln xijt (12)

= 4 + 244 ln xi4t + 2
k=4

4k ln xikt

Hence, the marginal cost for loans (from the notation j = 4), of bank i at time t, mci4t in equation (11) becomes mci4t Ci4t Ci4t = = 4 + 244 ln loans + 2 xi4t xi4t 4k ln xikt .
k=4

(13)

for k = 4. Using the notation dened on page 7 of j and k , we have that mci4t = + costs [4 + 244 ln loans + 214 ln wage + 224 ln f und + 243 ln othexp totalloans 245 ln sec + 246 ln othserv ]. (14)

Finally, it is worth mentioning that the marginal cost calculation in equation (14) is a bit dierent from equation (8) in the paper by van Leuvensteijn et al. (2007).

The Data

This section discusses the data used in detail and provides also the summary statistics for the variables used in this study by country and year. This study concerns the comparison of the competitiveness in the banking industry between two countriesthe United States and Thailand. It employed two data sourcesthe CALL Report data 8

of all U.S. banks and the Bankscope data for Thai banks. The U.S. is chosen as a comparative country for two reasons. First, the CALL Report provides the data that is very much detailed and complete. Second, the U.S. banking industry has been claimed to be very ecient and competitive among countries around the world. It also went through interesting policy transformations in the 1990s, notably the Riegle-Neal Interstate Banking and Branching Eciency Act of 1994 was passed, allowing banks to merge across states for the rst time, and the Gramm-Leach-Bliley Act of 1999, permitting banks and nancial institutions to oer non-bank products like investments and insurance-related services. These policies have consequences that would change the competitive dynamic in the U.S. banking industry which may be worth investigating. The time periods in consideration is from the years 1994-2004 both for the U.S. and for Thailand. The Bankscope data for Thailand contains only the commercial bank data so the regression by bank type is no longer applicable.6 For the U.S., there is a mix of commercial, savings and cooperative banks. Table 1 presents the number of banks in each country in each year.

TABLE 1: NUMBER OF BANKS USED FOR THE U.S. AND THAILAND BY YEAR
United States savings banks cooperative banks 526 84 511 83 508 83 484 81 467 77 467 75 449 75 439 74 420 73 412 72 390 70 Thailand commercial banks 13 13 13 13 13 13 13 13 13 13 12

year 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

commercial banks 10,430 9,919 9,509 9,126 8,760 8,562 8,295 8,062 7,871 7,753 7,613

This table presents the number of banks in each country by year and by type. The classication of U.S. bank types follow the entity code classication in the CALL Report.

The gradual decrease in the number of banks in the U.S. has been a trend since the passage of the Riegle-Neal in 1994. While the number of banks may have decreased over the years, the number of U.S. bank branches have been increasing, as the merged banks are converted into branches.7
6 Since the government-owned banks and SFIs may be aected by the central scal policies, I only consider commercial banks in this study. 7 For more information on U.S. branches, please see Spieker (2004).

I use the same system as in van Leuvensteijn et al. (2007). That is, total assets, loans, deposits, equity and other non-interest income should be positive; the deposits-to-assets ratio should be less than 0.98; loans-to-assets ratio should be less than 1; other income-to-assets ratio should be below 0.2; personnel expenses-to-assets and other expenses-to-assets ratio should be between 0.0005 (0.05%) and 0.05 (5%); and nally the equity-to-assets ratio should be between 0.01 and 0.5. Table 2 presents the summary statistics of the variables used in the TCF estimation (equation (6)) by bank type and in aggregate of type.

TABLE 2: MEAN VALUES OF VARIABLES USED IN THE TCF ESTIMATION REGRESSION FOR YEARS USED (in %)
United States savings cooperative 5.42 5.33 0.01 0.002 64.22 67.39 26.04 22.61 6.23 5.50 113.92 113.96 1.25 1.41 4.13 3.46 10.85 10.32 Thailand commercial 7.11 7.83 69.23 20.55 11.19 39.19 0.81 5.81 7.80

variable costs/total assets loan market share loans/total assets securities/total assets other services/total assets other expenses/xed assets personnel expenses/total assets interest expenses/total deposits total equity/total assets

commercial 5.41 0.01 59.35 26.85 10.41 146.95 1.63 5.04 10.26

all banks 5.41 0.01 59.66 26.77 10.16 145.03 1.60 4.98 10.29

This table presents the summary statistics for the variables used in the TCF regression, each expressed as a percentage or a share of factors used to normalize it.

Recall that the explanatory variables are grouped into two categories. The output group variables are loans, securities, and other services (proxied by non-interest income). The securities for the U.S. are book-value (instead of market-value) while the securities for Thailand are proxied by other earning assets. The input prices are calculated as follows. The wage variable is the ratio of the personnel expenses to total assets while the fund variable is calculated using the ratio of interest expenses to total deposits. Finally, the other expenses (variable othexp) input price is dened as the ratio of other non-interest expenses to xed assets, although for Thai banks other-operating expenses are used instead of other non-interest expenses. The costs is just the sum of interest expenses, personnel expenses and other expenses. From Table 2, it is obvious that the average loan market share per bank in Thailand is much higher than in the U.S. (7.83% vs. 0.01%). This implies that the loan market in Thailand is much

10

more concentrated. Thai banks also posssess a larger share of loans to assets than U.S. banks (69% vs. 60%). In aggregate, Thai banks bear higher total costs than U.S. banks (7.11% vs. 5.41 %) which may have been driven by high interest expenses, since the ratio of personnel and other expenses are lower than U.S. banks. The low ratio of equity to total assets conincide with the perception that Thai banks rely more on deposits as a source of fund.

The Regressions, Results and Analysis

The regression equations, results and analysis are discussed in this section. There are two regressions performed in this paper. First, the translog cost function (TCF) is estimated using the xed eect panel data regression. Then, the marginal costs for each bank and year are calculated. Second, the Boone indicator is calculated using the Generalized Method of Moments (GMM) with the marginal cost variable being instrumented by its own one-year lag. The analysis is embedded in each section dedicated to each step of the calculation.

3.1

Estimating the TCF and Calculating the Marginal Costs

The rst step is to estimate the TCF and then calculate the marginal cost for each bank in each year to be used in the Boone indicators calculation later. In order to do so, the TCF function in equation (6) is estimated using the xed-eect panel data regression. For the U.S., in addition to the time xed-eects, I also include the state xed-eects to control for dierences across states, which include dierent banking legislation. The translog cost function estimation results for each country and bank type (for the U.S. only) are presented in the appendix. Prior to carrying out the regression and in addition to careful measures already taken, I minimize the outliers problems further by winsorizing the top and bottom 1% of the data. This is to ensure that the results obtained are not driven by any particularly large values of the variables. Finally, a few observations may have negative or zero values. Since the TCF regression involves transforming the variables into the natural logarithmic form, if the values of the variables are zero or negative, they may not be dened. Therefore, these few observations are replaced by 1 and so ln(1) = 0.

11

After estimating the TCF, all the coecients needed in order to calculate the marginal cost of loansnamely 4 , 44 , 45 , 46 , 41 , 42 , 43 can be obtained. Table 3 presents the estimated values of these coecients.

TABLE 3: ESTIMATED COEFFICIENTS FROM THE TCF TO BE USED IN THE MARGINAL COST CALCULATION
United States savings 0.009 (0.185) 0.072*** (0.009) -0.100*** (0.010) -0.017 (0.013) 0.001 (0.018) 0.019 (0.021) -0.010 4,995 Thailand commercial 0.407 (0.293) 0.094*** (0.019) -0.161*** (0.025) 0.0002 (0.011) 0.118* (0.063) -0.064 (0.048) -0.029 139

coecient 4 44 245 246 241 242 43 observations

commercial 0.288*** (0.064) 0.073*** (0.003) -0.090*** (0.004) -0.051*** (0.004) 0.034*** (0.006) -0.015** (0.006) -0.009 93,664

cooperative 0.709*** (0.009) 0.068*** (0.001) -0.141*** (0.001) -0.011*** (0.001) -0.026*** (0.001) 0.031*** (0.001) -0.002 844

This table presents the estimated coecients from the TCF (equation (11)) estimation through the xed-eect panel data regression. Robust standard errors (for the U.S.) and standard errors (for Thailand) appear below coecients in parentheses. ***, ** and * indicate statistical signicance at 1 percent, 5 percent and 10 percent, respectively. The coecient 43 is indirectly estimated by the relationship 43 = 41 42 so no standard error is reported. For more details on the results of the TCF estimation, please see Tables A1-A2 in the appendix.

From the coecients in Table 3, the marginal cost for bank i in year t can be calculated using equation (14). In order to get a clear picture of the marginal cost of loans in the banking industry for each country in a year, the marginal cost of bank i is weighted by the loan market share (in %) of that bank rst and then added up within a year and a country. The results are presented in rst two columns of Table 4 below. In addition, the average marginal cost (i.e. equally-weighted by the market share) by type and year is also calculated and presented in the last three columns on Table 4 for the cross-type comparison within the U.S. For comparison purposes, the plot of the rst two columns of Table 4 is presented as Figure 1 and the last 3 columns as Figure 2 in the appendix. The estimated marginal costs for the whole banking industry (the rst two columns) reect that, on average, Thai banks had higher marginal costs than U.S. banks. Consequently, Thai banks were

12

TABLE 4: WEIGHTED AND AVERAGE MARGINAL COSTS OF ALL BANKS AND SEPARATED BY BANK TYPES IN EACH COUNTRY BY YEAR
Weighted by Market Share United States all banks 5.73 6.24 6.02 5.83 5.88 5.48 6.06 5.32 4.20 3.70 3.55 Thailand all banks 7.54 9.22 9.47 8.33 10.17 7.03 5.52 5.50 4.86 4.07 3.48 Equally-Weighted Marginal Cost* United States savings banks 5.39 6.07 6.21 6.02 6.06 5.82 6.05 5.93 5.04 4.42 4.09

year 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

commercial banks 5.93 6.36 5.78 7.06 3.85 5.95 6.45 7.41 5.06 4.51 4.23

cooperative banks 5.50 5.98 5.98 5.88 5.93 5.57 5.64 5.51 4.55 3.91 3.57

*The average of the equally-weighted marginal costs is presented in the 102 unit for an easier comparison with the market-share-weighted marginal costs. This table presents the market-share-weighted marginal costs for the whole banking industry within a given year and a country. Also, the unweighted equally-weighted marginal costs by bank type and by year is also oered.

operating ineciently compared to U.S. banks, although Thai banks were catching up fast in terms of eciency. In general, the marginal costs of banks in both countries had gradually decreased during this decade. Moreover, note that the surge in the marginal costs of Thai banks happened in 1998 and, hence, was consistent with the Asian Crisis lag eect. This huge jump of marginal costs (from 8.33 to 10.17) might have been contributed largely by the high interest rate policy implemented after the crisis, which could have led to a huge increase in interest expenses. A small increase in the marginal costs for U.S. banks in 2000 is in line with a gradual increase of the fed fund rates, which resulted in more than 1% increase in total compared to the rate at the beginning of 2000. The interest expenses of U.S. banks would have increased with this rate. When comparing against types of banks in the U.S., commercial banks bear highest costs in general and cooperative banks bear lowest costs. The nding that commercial banks in general have the highest marginal costs is consistent with the cross-country results of van Leuvensteijn et al. (2007). Finally, the deviation of the marginal costs estimated from the van Leuvensteijn et al. (2007) paper would have been contributed by dierences in the marginal cost equation (equation (14)), the data source and the methodology in estimating the TCF function.

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3.2

Estimating and Calculating the Boone Indicator

After obtaining the marginal cost by bank i and by year t for each country, then the Boone indicator can be estimated using the following equation.
T

ln Sit = +
t=2

t dt + ln mcit + uit

(15)

where Sit is the loan market share of bank i in year t. dt is the year t dummy variables and mcit is the marginal cost of bank i in year t. Estimating equation (15) gives us the Boone indicator for each country throughout the time periods used in this study. The estimations are carried out using the Generalized Method of Moments (GMM) using the lag marginal costs as an instrument for the marginal costs of the current period. The Hansen J-test is performed to test for the overidentication of the instruments.8 The variance estimations are performed using kernel-based heteroskedastic and autocorrelation consistent (HAC). Standard error reported therefore reects the correction of both arbitrary heteroskedasticity and arbitrary autocorrelation. The bandwidth in the estimation is set at two periods and the NeweyWest kernel is employed. 3.2.1 The Degree of Competition in the Whole Banking Industry

Table 5 presents the estimated Boone indicator for the banking industry in each country. The estimation is carried out using the pooled sample of all banks and all year to calculate the overall Boone indicator for the banking industry during the years in consideration.

TABLE 5: ESTIMATED BOONE INDICATOR FOR EACH COUNTRY

country Thailand United States Boone indicator -2.28*** -3.12*** z-value -4.59 -50.69 F-test 2.65 260.50 Hansen J-test 0.00 0.00 no. of banks 125 86,517

This table presents the estimated Boone indicator from equation (15). ***, ** and * indicate statistical signicance at 1 percent, 5 percent and 10 percent, respectively. The F-statistics are presented to show that the estimated value is statistically dierent from zero. Hansen J-Test is 0.00 since the equation is exactly-identied.

From Table 5, the Boone indicators ( ) of both countries show that the Thai banking industry is
8 The joint null hypothesis is that the instrument is uncorrelated with the error term. The chi-square test is used to test whether the number of degrees of freedom equal to the number of overidentication restrictions, which is the null hypothesis.

14

quite a bit less competitive compared to the U.S. banking industry. This can be seen from |T hai | = 2.28 < |U S | = 3.12, since the theory indicates that the eect of the change in the marginal costs on the loan market shares will be stronger in a more competitive environment. Also, the estimated Boone indicator for the U.S. in this study is slightly lower (in absolute value) than the estimation of van Leuvensteijn et al. (2007). This may be because the time periods covered in this study include the periods of the merger wave in the U.S. banking industry in the 1990s, which provided an additional policy shock on the structure of the loan market other than being aected by the change in the marginal costs alone. 3.2.2 The Trend of the Degree of Competition Across Years

In this section, the Boone indicator is re-estimated by year for each country. Due to the small number of data points in each year for Thailand, the estimated annual Boone indicator may not be statistically dierent from zero. The estimated annual Boone indicators are presented in Table 6. Also, the plots of the both countries Boone indicator trend as shown in Table 6 are presented as Figure 3 in the appendix.

TABLE 6: THE ESTIMATED ANNUAL BOONE INDICATOR BY COUNTRY

United States Boone indicator z-value -3.22*** -25.11 -3.10*** -22.69 -3.19*** -23.17 -3.04*** -21.21 -3.54*** -20.55 -3.65*** -19.47 -2.75*** -16.79 -3.03*** -18.71 -3.02*** -21.49 -2.85*** -21.16 Thailand Boone indicator -10.99 0.87 3.01 -10.09*** -8.44*** -1.56* -1.59* -1.17 -1.58** -2.72***

year 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

z-value -1.33 0.27 0.31 -4.33 -2.66 -1.94 -1.86 -1.15 -2.14 -4.10

This table presents the estimated annual Boone indicator for each country. Both countrys equations are exactly identied so the Hansen J-test is 0.00 and hence omitted from the presentation. ***, ** and * indicate statistical signicance at 1 percent, 5 percent and 10 percent, respectively. The F-stat for the U.S. is 150.16. The F-stat for Thailand is 5.43. The year 1994 is omitted because the lag value of the marginal cost is used as an instrument.

From Table 6, the results indicated that the U.S. banking industry has remained competitive despite the merger wave during the 1990s. Therefore, this nding is consistent with Jayaratine and

15

Strahan (1998) and DeYoung (1999), whose studies found that the deregulation in the 1990s led to more eciency and found no evidence of a reduction in competition after the policies were implemented. The Boone indicator for the U.S. banking industry uctuates between the -2.75 and -3.75 band. The level of competition had not been decreasing despite the reduction in the number of banks and an increase of an average loan market share of a bank. This is another evidence that looking at the market concentration alone may be misleading in determining the level of competition, as claimed by Boone et al. (2004). Although the estimation for Thai banks is highly volatile, which is to be expected for such a small sample size, some implications can be drawn from it. First, the Asian crisis may have changed the structure of the loan market and the expenses of banks during a few years following 1997. Therefore, the high value of estimated Boone indicator may have reected that the loan market share is much more sensitive to an increase in marginal costs for a country recovering from a severe nancial crisis. A more stable trend of the Boone indicator happens after the year 2000. The Thai banking industry had become more competitive compared to previous periods and the Boone indicator registered at -2.72 at the end of 2004. It seems like the market for loans in Thailand was on an upward trend when it comes to being competitive.

Concluding Remark
Measuring competition has always been an interesting issue as important policy implications can be drawn from it. Boone et al. (2004) developed a model to measure competition, relying on the theory that more ecient rms (i.e. with lower marginal costs) will possess higher market shares and this eect will be stronger in a more competitive environment. The study by van Leuvensteijn et al. (2007) applied the Boone concept to the banking industry for the rst time. Applying the similar concept as van Leuvensteijn et al. (2007), I measure the level of competition in the loan market of Thai and U.S. banks through estimating the Boone indicator. Using the data from the CALL Report (for the U.S.) and Bankscope (for Thailand) during the years 1994-2004,

16

I nd that the Thai banking industry is quite a bit less competitive during the years 1994-2004 compared to the U.S., as measured by the competitiveness in the loan market. In addition, the estimation of the translog cost function (TCF) points to the fact that Thai banks were operating more ineciently, as they bore higher marginal costs than U.S. banks. The policy implications that can be drawn from the results in this paper may lie upon the question of how to increase competition in the Thai banking industry. As Thai banks have been improving more in terms of competition, as can be seen from an upward trend of the absolute value of the Boone indicator, but more measures may be taken to accelerate the process of liberalizing the banking industry.

17

References
Berger, Allen N. and Loretta J. Mester. (1997) Inside the Black Box: What Explains Dierences in the Eciencies of Financial Institutions? Journal of Banking and Finance. Vol. 21, pp. 895947. Boone, Jan. (2000) Competition. CEPR Discussion Paper Series. No. 2636. Boone, Jan. (2004) A New Way to Measure Competition CEPR Discussion Paper Series. No. 4330. Boone, Jan, Rachel Grith, and Rupert Harrison. (2004) Measuring Competition. Paper presented at the Encore Meeting 2004. Boone, Jan, Jan C. van Ours, and Henry van der Wiel. (2007) How (not) to measure competition. Center for Economic Research Discussion Paper. Tilburg University, No. 2007-32. Bresnahan, Timothy. (1982) The oligopoly solution concept is identied. Economics Letters. Vol. 10, pp. 8792. Claessens, Stijin and Luc Laeven. (2004) What drives bank competition? Some international evidence. Journal of Money, Credit, and Banking. Vol. 36, pp. 563583. Jayaratne, Jith and Philip E. Strahan. (1998) Entry Restrictions, Industry Evolution and Dynamic Eciency: Evidence from Commercial Banking. Journal of Law and Economics. Vol. 41, No. 1, pp. 239-273. Panzar, John C. and James N. Rosse. (1987) Testing for monopoly equilibrium. Journal of Industrial Economics. Vol. 35, pp. 443456. Spieker, Ronald L. (2004) Bank Branch Growth Has Been SteadyWill It Continue? Future of Banking Study. Federal Deposit Insurance Corporation. Draft FOB200408.1. Van Leuvensteijn, Michiel, Jacob A. Bikker, Adrian A.R.J.M. van Rixtel, and Christoer Kok Srense. (2007) A New Approach to Measuring Competition in the Loan Markets of the Euro Area. European Central Bank Working Paper Series. No. 768, pp 1-37.

18

Appendix
1. Calculating the Translog Cost Function and the Marginal Costs in Detail
Given the translog cost function equation
H 1 h ln Cit T 1 H K

= 0 +
h=1 H K

h dh i +
t=1 K

t dt +
h=1 j =1

jh ln xijt dh i

+
h=1 j =1 k=1

jkh ln xijt ln xikt dh i + vit ,

and the classication of k and l as given j j j j j j =k =k =k =k =k =k =1 =2 =3 =4 =5 =6 for for for for for for the wage rates (variable name wage) the funding rates (variable name fund) the other expenses (variable name othexp) loans (variable name loans) securities (variable name sec) other services (variable name othserv),

the TCF can be rewritten in the following form (for each bank i of type h in year t so all these indices are omitted here), ln Costs = + + + + + + + + + + + + + 0 + t dt + 1 ln wage + 2 ln f und + 3 ln othexp + 4 ln loans 5 ln sec + 6 ln othserv + 11 ln wage2 + 12 ln wage ln f und 13 ln wage ln othexp + 14 ln wage ln loans + 15 ln wage ln sec 16 ln wage ln othserv + 21 ln f und ln wage + 22 ln f und2 23 ln f und ln othexp + 24 ln f und ln loans + 25 ln f und ln sec 26 ln f und ln othserv + 31 ln othexp ln wage + 32 ln othexp ln f und 33 ln othexp2 + 34 ln othexp ln loans + 35 ln othexp ln sec 36 ln othexp ln othserv + 41 ln loans ln wage + 42 ln loans ln f und 43 ln loans ln othexp + 44 ln loans2 + 45 ln loans ln sec 46 ln loans ln othserv + 51 ln sec ln wage + 52 ln sec ln f und 53 ln sec ln othexp + 54 ln sec ln loans + 55 ln sec2 56 ln sec ln othserv + 61 ln othserv ln wage + 62 ln othserv ln f und 63 ln othserv ln othexp + 64 ln othserv ln loans + 65 ln othserv ln sec 66 ln othserv 2

Using the conditions in equation (7), 3 = 1 1 2 and applying the symmetry between the coecients of the same cross variable j,k = k,j in equation (10),

19

ln Costs = 0 + t dt + ln othexp + 1 [ln wage ln othexp] + 2 [ln f und ln othexp] + + + + + + + + 4 ln loans + 5 ln sec + 6 ln othserv + 11 ln wage2 + 212 ln wage ln f und 213 ln wage ln othexp + 214 ln wage ln loans + 215 ln wage ln sec 216 ln wage ln othserv + 22 ln f und2 + 223 ln f und ln othexp 224 ln f und ln loans + 225 ln f und ln sec + 226 ln f und ln othserv 33 ln othexp2 + 234 ln othexp ln loans + 235 ln othexp ln sec 236 ln othexp ln othserv + 44 ln loans2 + 245 ln loans ln sec 246 ln loans ln othserv + 55 ln sec2 + 256 ln sec ln othserv 66 ln othserv 2 (16) From equation (8), we can expand it to be such that 1,1 + 2,1 + 3,1 1,2 + 2,2 + 3,2 1,3 + 2,3 + 3,3 Applying the symmetry j,k = k,j again yields 1,1 + 1,2 + 1,3 1,2 + 2,2 + 2,3 1,3 + 2,3 + 3,3 = 0 1,1 1,2 = 1,3 = 0 1,2 2,2 = 2,3 = 0 1,3 2,3 = 1,1 + 21,2 + 2,2 = 3,3 (17) (18) (19) = = = 0 0 0.

where the last part of equation (19) comes from applying equations (17)-(18) again to 1,3 and 2,3 . Expanding equation (9) gives us 4,1 + 4,2 + 4,3 5,1 + 5,2 + 5,3 6,1 + 6,2 + 6,3 7,1 + 7,2 + 7,3 Applying the symmetry j,k = k,j again yields 1,4 + 2,4 + 3,4 1,5 + 2,5 + 3,5 1,6 + 2,6 + 3,6 1,7 + 2,7 + 3,7 = = = = 0 1,4 2,4 0 1,5 2,5 0 1,6 2,6 0 1,7 2,7 = 3,4 = 3,5 = 3,6 = 3,7 (20) (21) (22) (23) = = = = 0 0 0 0.

Using equations (17)-(23) in equation (16), we have ln Costs = 0 + t dt + ln othexp + 1 [ln wage ln othexp] + 2 [ln f und ln othexp] + 4 ln loans + 5 ln sec + 6 ln othserv + 11 ln wage2 + 212 ln wage ln f und + 2[11 12 ] ln wage ln othexp + 214 ln wage ln loans + 215 ln wage ln sec + 216 ln wage ln othserv + 22 ln f und2 + 2[12 22 ] ln f und ln othexp + 224 ln f und ln loans + 225 ln f und ln sec + 226 ln f und ln othserv + [11 + 212 + 22 ] ln othexp2 + 2[14 24 ] ln othexp ln loans + 2[15 25 ] ln othexp ln sec + 2[16 26 ] ln othexp ln othserv + 44 ln loans2 + 245 ln loans ln sec + 246 ln loans ln othserv + 55 ln sec2 + 256 ln sec ln othserv + 66 ln othserv 2 20

Rearranging yields ln Costs = 0 + t dt + ln othexp + 1 [ln wage ln othexp] + 2 [ln f und ln othexp] + 4 ln loans + 5 ln sec + 6 ln othserv + 11 [ln wage ln othexp]2 + 212 [(ln wage ln othexp)(ln f und ln othexp)] + 22 [ln f und ln othexp]2 + 214 (ln loans)[ln wage ln othexp] + 215 (ln sec)[ln wage ln othexp] + 216 (ln othserv )[ln wage ln othexp] + 224 (ln loans)[ln f und ln othexp] + 225 (ln sec)[ln f und ln othexp] + 226 (ln othserv )[ln f und ln othexp] + 44 ln loans2 + 245 ln loans ln sec (24) + 246 ln loans ln othserv + 55 ln sec2 + 256 ln sec ln othserv + 66 ln othserv 2 Equation (24) gives the nal form of the regression of the TCF.

Next, recall that the marginal cost function for loans is dened by Ci4t Ci4t ln Ci4t = . xi4t xi4t ln xi4t =
ln Costs ln loans ,

mci4t = Basically, in order to determine respect to ln loans and so ln Costs ln loans

ln Ci4t ln xi4t

we should dierentiate equation (24) with

= 4 + 244 ln xi4t +
k=4

4k ln xi4t +
j =4

j 4 ln xijt

= 4 + 244 ln xi4t + 2
k=4

4k ln xikt

= 4 + 244 ln loans + 214 ln wage + 224 ln f und + 243 ln othexp + 245 ln sec + 246 ln othserv Hence, the marginal cost for loans is then C Ci4t mci4t = = 4 + 244 ln xi4t + 2 xi4t xi4t = +

4k ln xikt
k=4

Costs [4 + 244 ln loans + 214 ln wage + 224 ln f und + 243 ln othexp loans 245 ln sec + 246 ln othserv ],

which is equation (14).

2. The Results of the TCF Estimation of the U.S. and Thailand

The table below reports the estimated coecients and other important statistics from the TCF estimation regression.

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TABLE A1: THE RESULTS OF THE TCF ESTIMATION FOR COMMERCIAL BANKS OF BOTH COUNTRIES
Dependent variable: ln(costs)-ln(othexp) explanatory variables intercept ln loans(com) ln sec(com) ln othserv (com) ln eqtyratio(com) ln loans2 (com) ln sec2 (com) ln othserv 2 (com) ln eqtyratio2 (com) ln wage ln othexp(com) ln f und ln othexp(com) (ln wage ln othexp)2 (com) (ln f und ln othexp)2 (com) [(ln wage ln othexp)(ln f und ln othexp)](com) (ln loans)(ln wage ln othexp)(com) (ln loans)(ln f und ln othexp)(com) (ln sec)(ln wage ln othexp)(com) (ln sec)(ln f und ln othexp)(com) (ln othserv )(ln wage ln othexp)(com) (ln othserv )(ln f und ln othexp)(com) [ln loans ln sec](com) [ln loans ln othserv ](com) [ln sec ln othserv ](com) Adjusted R2 Total Observations coecients 0 4 5 6 7 44 55 66 77 1 2 11 22 212 214 224 215 225 216 226 245 246 256 Commercial Banks US estimation Thai estimation 1.713*** 3.616* (0.474) (2.153) 0.289*** 0.407 (0.064) (0.293) 0.246*** -0.408* (0.042) (0.239) 0.159*** 0.078 (0.046) (0.087) -0.666*** 0.039 (0.069) (0.055) 0.073*** 0.094*** (0.003) (0.019) 0.043*** 0.093*** (0.002) (0.013) 0.025*** 0.003 (0.002) (0.003) 0.134*** -0.053*** (0.014) (0.017) 0.661*** 0.922** (0.068) (0.379) 0.453*** -0.824*** (0.062) (0.293) 0.109*** 0.104*** (0.003) (0.035) 0.120*** 0.076*** (0.003) (0.026) -0.225*** -0.384*** (0.006) (0.058) 0.034*** 0.118* (0.006) (0.063) -0.015** -0.064 (0.006) (0.048) -0.025*** -0.176*** (0.004) (0.044) 0.010*** 0.082** (0.004) (0.033) -0.020** -0.003 (0.004) (0.015) 0.004 0.011 (0.005) (0.015) -0.090*** -0.161*** (0.004) (0.025) -0.051*** 0.0002 (0.004) (0.011) 0.005 -0.007 (0.003) (0.008) 0.992 0.993 99,188 139

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TABLE A2: THE RESULTS OF THE TCF ESTIMATION FOR SAVINGS AND COOPERATIVE BANKS FOR THE U.S.
Dependent variable: ln(costs)-ln(othexp) explanatory variables ln loans ln sec ln othserv ln eqtyratio ln loans2 ln sec2 ln othserv 2 ln eqtyratio2 ln wage ln othexp ln f und ln othexp (ln wage ln othexp)2 (ln f und ln othexp)2 [(ln wage ln othexp)(ln f und ln othexp)] (ln loans)(ln wage ln othexp) (ln loans)(ln f und ln othexp) (ln sec)(ln wage ln othexp) (ln sec)(ln f und ln othexp) (ln othserv )(ln wage ln othexp) (ln othserv )(ln f und ln othexp) [ln loans ln sec] [ln loans ln othserv ] [ln sec ln othserv ] dummies for savings and cooperative coecients 4 5 6 7 44 55 66 77 1 2 11 22 212 214 224 215 225 216 226 245 246 256 h U.S. Banks Savings Banks Cooperative Banks 0.009 0.709*** (0.185) (0.009) 0.323*** 0.411*** (0.083) (0.004) 0.128 -0.058*** (0.107) (0.007) 0.059 0.402*** (0.119) (0.004) 0.072*** 0.068*** (0.008) (0.001) 0.051*** 0.074*** (0.005) (0.001) 0.007 0.0132*** (0.004) (0.000) -0.015 -0.100*** (0.025) (0.001) 0.823*** 0.637*** (0.162) (0.017) 0.100 0.435*** (0.151) (0.018) 0.096*** 0.124*** (0.009) (0.002) 0.072*** 0.116*** (0.007) (0.003) -0.174*** -0.242*** (0.016) (0.004) 0.001 -0.026*** (0.017) (0.001) 0.019 0.031*** (0.020) (0.001) -0.011 0.032*** (0.011) (0.001) 0.002 -0.031*** (0.009) (0.001) -0.001 -0.003*** (0.012) (0.001) -0.015 -0.010*** (0.011) (0.001) -0.101*** -0.141*** (0.009) (0.001) -0.017 -0.010*** (0.013) (0.001) 0.001 -0.006*** (0.005) (0.000) 1.173 -4.994*** (1.222) (0.489)

The tables A1-A2 present the results of the xed-eect panel data regression of the translog cost function, as shown in equation (24). Robust standard errors (for the U.S.) and standard errors (for Thailand) appear below coecients in parentheses. ***, ** and * indicate statistical signicance at 1 percent, 5 percent and 10 percent, respectively.

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24

25