Efficiency Structure Hypothesis: An Application to the Argentine Banking Sector

Working papers (original series) | 2000 | N 12

Abstract

The convertibility plan has been accompanied by significant changes in banking policy: opening up of the banking sector to foreign competition, public bank privatization and tightening of the regulatory stance. As a result, the solvency and the liquidity of banking the banking system have improved but the degree of concentration has increased while bank profitability has declined. The latter two facts are consistent with the Efficiency-Structure Hypothesis in the sense that the increase in concentration and decrease in profitability can be viewed as an increase in efficiency. Burdisso and D'Amato (1999), however, present evidence that in Argentina not only are banks which are more X-efficient, les profitable but also that banks which operate in more concentrated (less competitive markets) have higher profitability. This evidence, on the other hand, lends weight to the Conduct Structure Performance Hypothesis in the sense that profitability is driven by market power and not by efficiency. We develop a partial equilibrium model of the banking sector with perfect competition and heterogeneous banks in the vein of the efficiency structure hypothesis that can explain the evidence above: If foreign banks are more X-efficient than local banks, and banking reform leads to lower opportunity costs of entering for large banks, entry into the banking sector results in higher concentration, lower profits and a more efficient banking sector. If the opportunity costs of entry are relatively lower in regions with more developed financial markets, we will observe that banks which operate in such regions might earn lower profits even if they are more X-efficient.

JEL classification: J54, O43