# Competition in the banking industry

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The banking system of a state plays a critical function in societal public assistance of the people in the state and of people of the universe in general. It offers services to endeavors and consumers to set about their concern activities and to easy execute their daily minutess. It is necessary to guarantee an efficient operation of the banking system ; otherwise, a dull and bogus banking system brings about an ultimate menace of potency for fiscal instability. That is the ground why the competition in fiscal sector is of much importance. The importance is for many grounds ; i.e. it relates to the efficiency, quality and invention of the production of fiscal services. Most significantly, it helps in taking careful determinations in policy devising for Bankss ( Claessens and Laevens, 2003 ) .

In recent old ages, a batch of research work has been carried out, look intoing the nature of competition in the banking industry along with the grade of competition, factors impacting the competition and the effects of competition on other market factors on micro degree every bit good as on macro economic degree.

An account for the huge sum of surveies on this subject is that competition can non be measured straight due to the deficiency of elaborate information on monetary values and costs of the assorted banking merchandises ( Bikker et al. , 2007 ) . This subject has besides gained popularity among bankers, economic experts and policy shapers because of globalization, liberalisation of fiscal markets and banking harmonisation all over the universe, particularly in the European Union.

Since early 90 ‘s, there are a batch of regulative alterations observed in the banking industry in order to accomplish the constitution of a individual, competitory market in the fiscal sector of Europe. It was ab initio triggered with the execution of the Second Banking Coordination Directive shaping conditions for Single Banking License.

As a effect, entry barriers have been removed well for the new entrants increasing competition, coupled with a important consolidation procedure. The intuition behind this was Market Contestability ; a market is contestable if there are no barriers to entry, issue is perfectly complimentary and the monetary values are extremely elastic to demands for industry end product. The cardinal thought is that a house may be compelled to be more competitory and efficient by the chance of new entrants ( Allen and Engert, 2007 ) . Furthermore, complimentary issue means that if a house enters into a new market and so decides to retreat, it is required to retrieve done for entry costs. These characteristics insure that even if a market has a little figure of active houses, it is still efficaciously contestable and competitory ( Nathan A. and Neave E. , 1989 ) .

Furthermore, the pro-competitive deregulating procedure has increased the degree of competition ( Cetorelli, 2004 ) , peculiarly in non-traditional and non-interest bearing countries of banking activity ( Goddard et al. 2001 ) .

Trivieri F. ( 2005 ) paperss that in the class of the 1990s, the Italian banking system underwent profound alterations at normative and institutional degrees, which led – among other things – to a important relaxation of the entry barriers, to the liberalization of bank ramification, to the redefinition of ownership construction and to a big figure of amalgamations and acquisitions.

The effects of these transmutations and, in peculiar, of those linked to the procedure of consolidation have been studied by many writers ( see, among others: Resti, 1997 ; Angelini and Cetorelli, 2000 ; Messori, 2001 ; Sapienza, 2002 ; Focarelli et al. , 2002 ; Focarelli and Panetta, 2003 ) .

Harmonizing to European Central Bank 1999, 29 per centum Bankss had been merged or shrunk between 1985 and 1997. In Italian banking industry, the Second Banking Directive was implemented in 1993, followed by a 20 per centum decrease in the figure of Bankss as a consequence of consolidation. It is observed that competition has been increased in recent old ages in European banking markets which is besides by and large true for Italy.

Angelini and Cetorelli ( 2000 ) citation that a rise in the competition is easy found in European banking markets during recent old ages. Danthine, Giavazzi, Vives and von Thadden ( 1999 ) describe a slightly generalised lessening in Bankss ‘ net involvement borders across Europe during the 1990s. Consistent with the European grounds, a worsening tendency in bank borders is besides observed across different markets in Italy.

This paper focuses merely on the banking industry of Italy and analyzes the rating of competitory conditions, nature and the grade of competition in the Italian banking industry utilizing firm-level balance sheet informations.

In this paper, we explore more exhaustively the competitory nature and grade of competition in the Italian banking industry by following a methodological analysis developed in empirical industrial organisation and used extensively in banking. Further more, we will compare our consequences with old consequences to happen out that whether the grade of competition has been increased or it has been every bit same as it was in the yesteryear.

The apparatus of the balance of this paper is as follows. Section 2 contains some of import information about construction and characteristics of a competitory banking industry which helps in understanding the competition more exhaustively. Following Section 3 introduces the original Panzar-Rosse theoretical account along with the old surveies in the field. Section 4 gives a brief account of the general Panzar and Rosse theoretical account. This subdivision besides shows the reading of the H-statistic along with the description of the proving hypothesis. Following Section 5 trades with the empirical theoretical account used in this survey including long-term equilibrium trial. This subdivision besides contains the Bankss ‘ informations used for the empirical illustration for our theoretical findings. Finally in the last Section 6 empirical consequences and decision is discussed.

OPTIMAL COMPETITIVE STRUCTURE OF THE BANKING SYSTEM

Harmonizing to Northcott C. ( 2004 ) , competition improves efficiency and growing in the banking sector but market power or concentration is necessary for stableness in the industry. Furthermore, competitory environment promotes productive and allocative efficiency taking towards economic systems of graduated table while market power improves recognition handiness, stableness, quality of Bankss ‘ loan portfolios, showing of loans and supervising them.

As a consequence, market power should non be eliminated, but instead used to ease an environment that promotes competitory behavior.

FEATURES OF A COMPETITIVE Banking Industry

Concentration weakens competition by furthering conniving behavior among houses. Increased market concentration was found to be associated with higher monetary values and greater than normal net incomes ( Bain, 1951 ) . Smirlock ( 1985 ) and Evanoff and Fortier ( 1988 ) argue that higher net incomes in concentrated markets could be the consequence of greater productive efficiency. Berger ( 1995 ) finds some grounds that the efficiency hypothesis holds in US banking. In Europe, on the other manus, structural factors appeared to be more of import and the SCP hypothesis seemed to keep ( Goddard et al. , 2001 ) .

If a well-developed fiscal system is provided so contestability improves with new entrants. Contestability is non needfully related to concentration or the figure of Bankss. Concentration and competition can be together because of the presence of asymmetric information and subdivisions and the consequence and usage of new engineerings. ( Northcott C, 2004 )

LITERATURE REVIEW AND THEORETICAL ISSUES:

Harmonizing to Bikker and Haaf ( 2000 ) , ab initio the economic literature on the issue of competition in the industrial sector can be divided into two chief classs ; structural attack and non-structural attack. Structural attack can be farther divided into two chief paradigms.

First type of structural attack is Structure-Conduct-Performance ( SCP ) paradigm, which tells us that the grade of competition is determined by the structural features of the market, such as, figure of houses, size of the houses, etc. The SCP was developed in the early 1950 ‘s by Mason ( 1939 ) and Bain ( 1951 ) . Bain ( 1951 ) constructs the market power hypothesis that conniving behavior is initiated by high concentration which consequences in big net incomes for houses. Subsequently, Stigler ( 1964 ) and Demsetz propose efficiency hypothesis in contrast of marker power hypothesis saying that the efficiency of bigger houses may be the ground for high concentration alternatively of conniving behavior of houses, while during 1980 ‘s, Baumol, Panzar and Willig ( 1983 ) build contestability hypothesis. Their hypothesis provinces that if entry and issue barriers are relaxed so competition may be prevailed ( Mkrtchyan A. 2005 ) .

Second attack is Efficient-Structure-Hypothesis ( ESH ) , which states that greater concentration in the industry non merely increases the degree of efficiency in the sector but besides increases the grade of competition in that sector.

Non-structural attack is based on depicting the nature of competition in the context of the surveies of New Economic Industrial Organization ( NIEO ) . It suggests non-structural theoretical accounts to analyze the competition in markets which do non trust on the markets ‘ construction. Particularly, Klein ( 1971 ) , Baumol, Panzar, and Willig [ 1982 ] supply a theory that shows that market fight can be inferred irrespective of the construction of the market.

NIEO surveies include Iwata Model ( 1974 ) , Brasnahan Model ( 1982 ) , Rosse and Panzar ( 1977 ) , Panzar and Rosse ( 1982 ) , Panzar and Rosse Model ( 1987 ) , etc. Non-structural method or house ‘s input-output cost surveies have gained more popularity than the structural attack among faculty members, research workers, analysts and policy shapers. Particularly Panzar and Rosse theoretical account ( 1987 ) is the most widely used and is really popular theoretical account for competition.

Duncan ( 2003 ) references that the Panzar and Rosse ( P-R ) theoretical account provides a comprehensive and simple method to cipher the competition. It does non necessitate intensive informations as compared to other theoretical accounts and has been steadfastly related to theoretical side. The information required for this theoretical account is easy available as it calculates the amount of the factor monetary values ‘ snaps estimated from a decreased signifier of gross map.

The Rosse-Panzar trial has been developed to analyze competitory conditions in the visible radiation of the contestability theory ( Rosse and Panzar, 1977 ; 1982 ; 1987 ) . This attack measures the grade of competition by analysing how each bank ‘s grosss react to alterations in input monetary values. It has chiefly emerged to prove market conditions that encompass all spectrums of fight off from the limitations brought approximately by the structural constructs. Basically, it depends on the relationship between gross grosss of the house and the alteration in its input monetary values by utilizing a statistic – which is called the H-statistics – that measures the amount of snaps of entire gross with regard to each input monetary value. As this attack includes the gross equation so for Bankss, chiefly the grosss are involvement gross. In this attack, h-statistics is used to mensurate the grade of competition. The H-statistics will state us the reactivity of grosss to the alterations in input monetary values. If h-statistics is less than or equal to zero so there will be monopoly, if it is between nothing and one so there will be monopolistic competition and if it is equal to one so there will be perfect competition ( Greenberg J. and Simbanegavi W. ) .

This attack is preferred when proving the information of different single Bankss. Furthermore, P-R attack outputs similar consequences without any ambiguity as it has clearly defined hypotheses with specific readings.

PREVIOUS GENERAL STUDIES ABOUT BANK COMPETITION:

Rearrange the literature reappraisal harmonizing to the claessens and neave.

A great figure of documents have been written on look intoing competition in the banking industry utilizing Panzar and Rosse theoretical account ( 1987 ) . But the motives for analysing the nature of the competition are immensely varied like part of institutional and structural factors, growing, parts, stableness, funding, efficiency, contestability, consolidation, cross-border capital flows, hazards etc.

The sum-up of the old plants and their findings can be seen in the Appendix Table 1.

Panzar J. and Rosse J. ( 1987 ) develop trial for Monopoly and utilize additive arrested development theoretical account to gauge the H-statistic for the newspaper industry, describing that it is obscure to reason that the newspaper houses earn oligopoly net incomes. Looking at the cross-country surveies carried out in the EU banking markets, one of the earliest analysis is undertaken by Molyneux et Al. ( 1994 ) who test the Panzar-Rosse statistics on a sample of Bankss in France, Germany, Italy, Spain and the UK for the period 1986-89. Consequences indicate monopolistic competition in all states except Italy where the monopoly hypothesis can non be rejected.

Shaffer and Disalvo ( 1994 ) usage this trial to analyse the information of a duopoly banking market in south cardinal Pennsylvania to exert the process for concentration and competitory behavior.

Waleed Murjan and Cristina Ruza ( 2002 ) examine the Arab Middle Eastern banking markets with this trial concluding that the banking sector is more competitory in non-oil-producing states than the banking industry in oil-producing states.

Gelos and Roldos ( 2002 ) use this method on 8 different states of Latin America and Europe, happening that market contestability prevents the competitory force per unit area from worsening which can go on because of the consolidation while Claessens and Laeven ( 2003 ) procedure the information of 50 states obtaining the same consequences.

Bikker and Haaf ( 2002 ) assess the banking industry in 17 European states and six states that are outside of Europe comparing competitory conditions and market construction.

Goddard, J. and Wilson, J. ( 2006 ) study misspecification prejudice in the gross equation for the banking sectors of 19 developed and developing states. They suggested a dynamic gross equation for indifferent appraisal instead than fixed effects appraisal which is badly colored towards nothing.

Gilbert ( 1984 ) and Berger ( 1995 ) test the information for 8,235 Bankss in 23 developed states bring forthing the consequences that a higher grade of market power has less hazard exposure.

Yuan Y. ( 2005 ) assesses the competition in Chinese Banking sector and comes up with the consequences that China already has had absolutely competitory status before new foreign entrants and it still has the same state of affairs.

Duncan D. ( 2003 ) presents the empirical appraisal of the market construction of the Jamaican banking sector and competitory tendencies in the market happening monopolistic behavior.

Al-Muharrami S. et Al. ( 2006 ) take GCC Arab states into observation and suggest that Kuwait, Saudi Arabia and the UAE operate under perfect competition ; and Bahrain and Qatar operate under conditions of monopolistic competition.

Nathan A. and Neave E. ( 1989 ) exercise the trial on Canadian fiscal industry and reject the hypothesis of monopoly power in Canada ‘s fiscal system.

PREVIOUS STUDIES ABOUT COMPETITION IN ITALIAN Banking Industry:

A great figure of surveies on competition in fiscal sector of EU states have been reported which besides include Italy in general. But there are besides some research-papers which are produced specifically for Italy. Some of them are:

Cetorelli N. and Angelini P. ( 2000 ) analyze the instance of the Italian banking industry and citation that competitory conditions have improved well after 1992, and it is believed that the debut of the Single Banking License in 1993 besides helps furthering the competitory behavior in Italian banking industry.

Dell’Ariccia G. and Bonaccorsi E. ( 2003 ) look into the relationship between bank competition and house creative activity. They document that the effects of competition in the banking sector on the creative activity of houses in the non-financial sector are less favorable to the outgrowth of new houses in industries where information dissymmetries are greater.

Coccorese P. ( 2002 ) rejects the theory that competition can be easy reduced by the conniving behavior of the houses, and comes up with the decision that strong concentration does non needfully prevent competition among houses.

Trivieri F. ( 2005 ) compares the Bankss involved in the cross-ownership and Bankss that are non involved. He finds that Italian Bankss involved in cross-ownership are less competitory than the Bankss which are non involved in cross-ownership, therefore turn outing cross-ownership lessenings competition.

GENERALIZED PANZAR AND ROSSE ( 1987 ) Approach:

## P-R theoretical account premises:

First, there are some premises and conditions in which Panzar and Rosse theoretical account plants. The theoretical account supposes that Bankss operate in long tally equilibrium. Although Goddard Wilson ( 2006 ) , paperss that this status is non needed any more if a right specified dynamic gross equation is adopted which permits virtually indifferent appraisal of the H-statistic. This eliminates the demand for a market equilibrium premise, but incorporates instantaneous accommodations as a particular instance. So in this paper long run equilibrium posit holds. Another premise is that the market participants affect the public presentation of the Bankss by their actions. Another posit is that the monetary value snap of demand is greater than integrity. Furthermore, the theoretical account posits that there is a homogeneous cost construction. Furthermore, net incomes are maximised to obtain the equilibrium figure of Bankss and the equilibrium end product. In long rum equilibrium, it is known that Bankss maximise their net incomes when, fringy gross peers to fringy cost ( Bikker and Haaf, 2000 ) . Trivieri F. ( 2005 ) besides adds that the Bankss are treated as individual merchandise houses which chiefly provide intermediation services.

## Explanation OF PR MODEL:

Claessens and Laeven ( 2003 ) citation that the Panzar and Rosse theoretical account surveies the impact of alterations in factor input monetary values reflected in equilibrium grosss by a specific bank.

Bikker and Haaf ( 2000 ) write that Panzar and Rosse theoretical account gives simple theoretical accounts for oligopolistic, competitory and monopolistic markets. This trial works on the reduced signifier gross equation and uses H-statistics. This H-statistics can state us non merely the nature of competition but besides gives information about the grade of the competition. H-statistics if steps between 0 and 1, it is monopolistic competition, 0 is considered as monopoly and 1 as perfect competition. Here, a general banking market theoretical account is used, which determines equilibrium end product and the equilibrium figure of Bankss by maximizing net incomes. The theoretical account is besides able to let for bank-specific variables in the equation.

Harmonizing to Bikker and Haaf ( 2000 ) , in the long tally equilibrium, it is known that Bankss maximise their net incomes at the break-even point. The break-even point is where fringy gross peers fringy cost. So, the bank I maximises its net incomes, where fringy gross peers fringy cost:

## ( 1 )

Ri refers to grosss and Ci to costs of bank I ( the prime denoting fringy ) , xi is the end product of bank I, N is the figure of Bankss, wi is a vector of thousand factor input monetary values of bank I, zi is a vector of exogenic variables that shift the bank ‘s gross map, Ti is a vector of exogenic variables that shift the bank ‘s cost map. Second, it means that in equilibrium at the market degree, the nothing net income restraint holds ( Bikker and Haaf, 2000 ) :

## ( 2 )

Variables marked with an star ( * ) represent equilibrium values. Panzar and Rosse define a step of competition H as the amount of the snaps of the reduced-form grosss with regard to factor monetary values ( Bikker and Haaf, 2000 ) :

## ( 3 )

Harmonizing to Khan, M. ( 2009 ) , it measures the per centum alteration in ( equilibrium ) gross due to a one per centum alteration in all input factor monetary values ( alteration in cost ) . From dichotomy theory, it is known that one per centum addition in factor monetary values will take to one per centum upward displacement in cost map. The impact of this displacement in cost map on the ( equilibrium ) gross of the Bankss is straight related to the grade of competition in the banking sector.

Bikker and Haaf ( 2000 ) further explain that Panzar and Rosse prove that under monopoly or under absolutely conniving oligopoly, an addition in input monetary values will increase fringy costs, cut down equilibrium end product and later cut down grosss ; hence H will be zero or negative. An addition in input monetary values raises both fringy and mean costs by an equal proportion as the cost is homogenous of degree one in input monetary values without changing the optimum end product of any single house. Exit of some houses increases the demand faced by each of the staying houses, thereby taking to an addition in monetary values and entire grosss by as same sum as the rise in costs, ensuing perfect competition where H-statistic is positive but non greater than integrity. In this instance fringy and mean cost will be increased by the rise in input monetary values ( Nathan A. and Neave H. , 1989 ) .

## Interpretation OF H-STATISTICS:

Panzar and Rosse prove that, under monopolistic competition, H is between nothing and integrity. H is a diminishing map of the sensed demand snap, so H increases with the fight of the banking industry. As a consequence, this H-statistic can function as a uninterrupted reading of the fight. Although this is non mentioned by Panzar and Rosse ( 1987 ) but with some premises this uninterrupted reading is right. So, the testable hypotheses are: The banking industry is characterised by monopoly for H=0, monopolistic competition for 0 & lt ; H & lt ; 1, and perfect competition for H=1 ( Bikker and Haaf, 2000 ) . The brief illustration of H-statistic can be found in the Appendix Table 2.

## HYPOTHESIS TESTING ;

Khan, M. ( 2009 ) references:

## Reversible Perfect Competition Test:

Keeping the long tally equilibrium posit, if Bankss are runing under perfect competition, a one per centum alteration in cost will take to a one per centum alteration in grosss. Output will non be changed if the demand map is absolutely elastic under perfect competition, end product monetary value and cost both will increase by the same extent. This implies that under perfect competition, H-statistic will be equal to one. Statistically, we will prove the undermentioned hypothesis.

H0: H = 1 Perfect competition prevails in the banking sector.

H1: H a‰ 1 There is no perfect competition in the banking sector.

## Reversible Monopolistic Competition Test:

If Bankss are runing in monopolistically competitory environment, one per centum addition in cost will take to less than one per centum addition in gross as the bank faces reasonably inelastic demand map. Statistically, we will prove the undermentioned hypothesis.

H0: 0 & lt ; H & lt ; 1 Banks are runing in a monopolistic competition environment.

H1: H a‰¤ 0 or H a‰? 1 Banks are non runing in a monopolistic competition environment.

## Nonreversible Monopoly Trial:

Standard theory of market construction suggests that the amount of factor input monetary value snaps should be less than zero if the underlying market construction is monopoly. Statistically, we will prove the undermentioned hypothesis.

H0: H a‰¤ 0 Banks are runing in a monopoly status.

H1: H & gt ; 0 Banks are non runing in a monopoly status.

( Khan M. , 2009 )

## EMPIRICAL FRAMEWORK AND METHODOLOGY:

The trial is robust with any definition of market whether it is within the national boundaries or it is the planetary international banking industry because there is no demand to stipulate a geographic market. Before proving, it is normally necessary to obtain a decreased signifier of gross equation which consists of gross as a dependant variable, factor input monetary values as independent variables and some controlled or house ‘s specific factors. The basic equation is:

Entire involvement gross = entire cost + controlled variables + mistake term

The panel information is used in the paper which is the informations collected over multiple clip periods. It is the combination of cross-sectional and clip series dimensions. Hence, it can be derived as:

Ci = a + Byi + Ei ( 4 )

Ct = a + Byt + Et ( 5 )

Where, C is the dependent variable, a is changeless term, B is the coefficient of the independent term, Y is the independent variable and E is the error term. Uniting both the equations ( 4 ) and ( 5 ) , the concluding basic equation can be given as:

Cit = a + Byit + Eit ( 6 )

But Panzar and Rosse define the H as the amount of the snaps of the reduced-form grosss with regard to factor monetary values, so the econometric theoretical account of the Panzar and Rosse statistic may be represented by the undermentioned equation:

( 7 )

For one = 1, … ..I ; t = 1, … … T ;

Where, R is a step of gross gross. W is a vector of factor monetary values ( the H statistic is given by the amount of the estimated coefficients of the variables in this vector ) ; S is a vector of scale variables ; X is a vector of exogenic and bank-specific variables that may switch the cost and gross agenda, Iµ indicates the error term ; I is the entire figure of Bankss ; T is the figure of periods observed ( Trivieri, 2005 ) . To cipher the amount of elasiticities, it is necessary to gauge the log additive theoretical account alternatively of gauging a simple additive theoretical account that is the ground for taking the log of all the variables in equation ( 7 ) .

The mark of the variables of different costs and bank specific variables are positive demoing a direct relationship to grosss ( Trivieri, 2005 ) .

In this pooled arrested development, excess intercepts or ‘dummies ‘ for clip are used, but silent persons for persons are non included because of the application of within-group-estimators. Because with-in-group calculator takes first difference and removes the persons silent persons variables by itself. Therefore being a fixed effects theoretical account, it measures differences in intercepts for each group and the differences are calculated by a separate silent person variable for each group ( Trivieri, 2005 ) .

The usage of fixed effects panel arrested development with clip silent persons allows ciphering the relevant parametric quantities of the empirical theoretical account. Furthermore, unseen heterogeneousness is controlled by the fixed effects excessively avoiding omitted variable jobs ( Trivieri, 2005 ) .

In this paper, the intermediation attack developed by Sealey and Lindley ( 1977 ) , is followed which tells that sedimentations, labor and capital are inputs for the Bankss. The empirical theoretical account applied in this paper is as:

LGIRTA =

B1LLABCOST + B2LCAPCOST + B3LFUNDCOST + B4LLTA + B5LBMIX

## ( 8 )

Where,

LGIRTA = Log of Gross Interest Revenues over Total Assetss

LLABCOST = Log of Labour factor monetary value

LCAPCOST = Log of Capital Cost

LFUNDCOST = Log of Funding Cost

LLTA = Log of Loans to Total Assetss

LBMIX = Log of Loans to Banks and Clients over Entire Loans

This paper addresses the banking industry of Italy. The information includes 480 Bankss about, of all sizes in Italy. The information contains two different samples. First sample consists of the informations from 1995 to 1997, entire 3 old ages, and the 2nd sample contains informations from 1997 to 2000, entire 3 old ages. We make a comparing and illation between the consequences obtained by these two samples through our empirical theoretical account and happen out the competitory behavior of Italian fiscal market.

## LONG RUN EQUILIBRIUM Trial:

An of import implicit in status of the H-statistic for competition is the long tally equilibrium. Panzar and Rosse ( 1987 ) citation that this posit is important for the instances of perfect competition and monopolistic competition. Though, it is non a cardinal premise in the instance of monopoly because when H is less than or equal to zero so it is a long tally premise for monopoly ( Trivieri, 2005 ) .

Long tally equilibrium trial for the observations can be done with the requirement that: “ competitory markets equalise the return rates across houses, so that in equilibrium these rates should non be correlated with input monetary values ” ( Trivieri, 2005 ) .

In our empirical theoretical account as in Shaffer ( 1982 ) , this trial can be carried out by re-estimating the equation with the placeholder for the return on assets, ROA, as dependent variable in the computation of H. In this context, H = 0 implies that the informations are in long tally equilibrium ( Trivieri, 2005 ) . The intuition behind this theory is that, return on assets, ROA, should non be related to input monetary values.

De Bandt and Davis ( 1999 ) , define the equilibrium status as the province in which alterations in banking sector are considered as gradual, long tally equilibrium for the observations does non intend that competitory conditions remain the same and do non alter through out the period of observations ( Trivieri, 2005 ) .

Although it is inappropriate to utilize Rosse-Panzar trial which is based on a inactive equilibrium model, but in the existent fiscal market, the equilibrium accommodations are less than instantaneous, ensuing disequilibrium on some points in clip or often, or ever. Furthermore, when it is known that the accommodations towards equilibrium are partial and non instantaneous so utilizing fixed effects appraisal for the inactive gross equation will ensue in colored H-statistics toward zero ( Goddard J. and Wilson J. , 2006 ) .

For the long tally equilibrium, we estimate the undermentioned equation:

LROA =

B1LLABCOST + B2LCAPCOST + B3LFUNDCOST + B4LLTA + B5LBMIX

## ( 9 )

## DATA AND SAMPLE DESCRIPTION:

The empirical portion of this paper uses an imbalanced panel informations set on which the Panzar and Rosse methodological analysis has been applied incorporating a scope of Italian banking houses. The information and the samples used for the appraisal of H index are provided by Dr. Leone Leonida, Queen Mary, University of London.

The informations used in this paper are one-year and refer to the period 1995-1997 ( 3 old ages ) for the first sample. The first sample for the econometric analysis is made up of an imbalanced panel informations of 480 fiscal establishments of all sizes, for a sum of 1401 observations. The figure of parametric quantities is 487. The longest clip series is 3 old ages long and the shortest clip series is merely 2 old ages long with 2 clip silent persons.

The 2nd sample covers the period of 1998-2000 ( 3 old ages ) holding 1330 figure of observation from 474 Bankss of all sized. The figure of parametric quantities is 481. The longest clip series is 3 old ages long and the shortest clip series is 2 old ages long picturing imbalanced panel informations with 2 clip silent persons.

In the Appendix, Table 3 provides a sum-up of the definition of relevant dependant variable, independent variables, bank specific factors ‘ variables and control variables.

“ LGIRTA ” is the log of gross involvement gross over entire assets, which is used as dependent variable, besides used by De Bandt and Davis ( 2000 ) , and Trivieri F. ( 2005 ) . Trivieri ( 2005 ) points out that harmonizing to Vesala ( 1995 ) and De Bandt and Davis ( 2000 ) it is the most appropriate pick because it so represents a monetary value equation and non the gross equation. Furthermore, our equation will be consistent with the conceptual construction used by the application of Panzar and Rosse ‘s statistic to the banking sector. The pick for taking merely the involvement portion of the entire gross of Bankss is consistent with implicit in impression of the P-R theoretical account that fiscal intermediation is the nucleus concern of most Bankss. However, Shaffer ( 1982 ) and Nathan and Neaves ( 1989 ) have included entire gross alternatively of merely involvement gross because of the fact that Bankss have increased their non-interest activities and services which have started generating income other than involvement. But still the consequence of other income on Bankss ‘ grosss is negligible.

“ LLABCOST ” is the cost of personal outgos which include rewards, wages, general and administrative costs ( Murjan and Ruza, 2002 ) .

“ LCAPCOST ” is the log of placeholder for the capital cost which includes depreciation which is written down on intangible and touchable assets, like physical depreciation, depreciation of investing securities and other operating expenses, the amount of which is expressed as a ratio over entire assets ( Murjan and Ruza, 2002 ) .

“ LFUNDCOST ” is the log of placeholder for the cost of support. If we treat the Bankss as houses to be able to use Panzar and Rosse attack, so we can see loans and investings as end product green goods by Bankss. Deposits and other supports are regarded as the Bankss ‘ productive inputs. Interest disbursals comprise of involvement paid on sedimentations, involvement paid on adoption, and other involvement paid, whereas involvement bearing financess includes clients ‘ sedimentations, interbank sedimentations, subordinated debt, and other long-run debt ( Murjan and Ruza, 2002 ) .

“ LLTA ” is the log of loans to entire assets. It is chosen to account for bank-specific hazard. In peculiar, it reflects both recognition and involvement rate hazard, given the particular characteristics of loans in the bank ‘s portfolio of assets. In rule, a high ratio is declarative of bank ‘s comparative illiquidity and limited capacity of farther loaning, but positively associated with grosss ( Murjan and Ruza, 2002 ) .

## Empirical Consequence:

Empirical RESULTS FROM THE FIRST Trial:

The H-statistic for the first sample is H = 0.6255 which indicates monopolistic competition. The goodness of tantrum, R-squared ( R^2 ) which shows the per centum of fluctuation in the dependant variable ( LGIRTA ) explained by the independent variables, is 0.8777 or 87.77 per centum. The surety about the selected estimation, or standard mistakes for labor cost ( LLABCOST ) , capital cost ( LCAPCOST ) , cost of support ( LFUNDCOST ) , loans to Bankss and clients over entire loans ( LBMIX ) and loans to entire assets ( LLTA ) are 0.06517, 0.01071, 0.5707, 0.03993 and 0.02403, severally. The distance of the observations from the mean or standard divergence is 0.04719 and the discrepancy is 0.002227. Wald trial for clip, silent person and joint trial, all are important for our explanatory variables indicating out the importance of the variables included in the theoretical account. However, at the 99 per centum degree of assurance merely cost of support ( LFUNDCOST ) is important explicating the dependant variable really good, while other variables holding really high t-probabilities are non sufficiently explicating the dependant variable. The void hypothesis for H = 1 and the nothing for H = 0, both are rejected. For full consequences, consult Table 4 in the appendix

Empirical RESULTS FROM THE SECOND Trial:

The H-statistic for the first sample is H = 0.6373 which indicates monopolistic competition. The goodness of tantrum, R-squared ( R^2 ) which shows the per centum of fluctuation in the dependant variable ( LGIRTA ) explained by the independent variables, is 0.0.8814 or 88.14 per centum. The surety about the selected estimation, or standard mistakes for labor cost ( LLABCOST ) , capital cost ( LCAPCOST ) , cost of support ( LFUNDCOST ) , loans to Bankss and clients over entire loans ( LBMIX ) and loans to entire assets ( LLTA ) are 0.05139, 0.01355, 0.03358, 0.03045 and 0.04634, severally. The distance of the observations from the mean or standard divergence is 0.05417 and the discrepancy is 0.002934. Wald trial for clip, silent person and joint trial, all are important for our explanatory variables indicating out the importance of the variables included in the theoretical account. While, at the 99 per centum degree of assurance labor cost ( LLABCOST ) , capital cost ( LCAPCOST ) and cost of support ( LFUNDCOST ) all are important explicating the dependant variable really good. However, other variables like loans to entire assets ( LLTA ) and loans to Bankss and clients ( LBMIX ) have really high t-probabilities and are non sufficiently explicating the dependant variable. The void hypothesis for H = 1 and the nothing for H = 0, both are rejected.

For full consequences, consult Table 5 in the appendix.

Discussion ON RESULTS:

In the consequences obtained from both the samples, the H-statistic values for the empirical theoretical account used go on to lie between 0 and 1. The consequences are statistically important ; most of the coefficients have the expected mark, although some are non statistically important. Hence, it can be quoted that during the ascertained periods Bankss earn their grosss under monopolistic competition. The H-statistic for the first sample is H = 0.6255, and for the 2nd sample is H = 0.6373. Therefore it is appropriate to reject the hypotheses that Bankss work under monopoly conditions, divinatory fluctuations of short-term oligopoly or perfect competition.

In footings of other exogenic variables, the coefficient of cost of support is positive and extremely important in both the consequences. Thus, cost of support plays a polar function in finding the Italian Bankss ‘ degree of grosss. Other independent variables have really minor impact on grosss.

Decision:

An of import determination revealed by this survey is that the banking industry of Italy operates and earns its grosss under the conditions of monopolistic competition. The little difference in the consequences of the two samples is negligible. The ground could perchance be the effects of some minor unsimilarities between the two samples. During the ascertained period of 6 old ages in sum of both the samples, the grade of competition has non been changed in Italy.

In the instance of Italy, it had been gaining grosss as if under monopoly or divinatory fluctuations short-term oligopoly conditions in 1989 ( Molyneux et al. 1994 ) . The competitory conditions comparatively unchanged until 1992, and started acquiring improved afterwards demoing indicants of monopolistic competition ( Cetorelli N. and Angelini P. 2000 ) . On the other manus, De Bandt and Davis ( 2000 ) reported monopolistic competition in Italy. The consequences of this survey are in line and consistent with the consequences of the latest literature of the field every bit good as with the old research work.