Regulations on Domestic and Foreign Bank Entry
Another issue, which is paid much attention, is regulation on bank entry. There are two opposing views about the regulation on bank entry in economic theory.
The supporters of regulation on bank entry stress the following arguments:
1. Effective regulation allows only healthy banks to enter the banking market and thus increase stability.
2. In reality markets often fail, so competition may not lead to lower prices and increased choice or it may lead to excessive choice but not innovation. Banks with monopolistic power may have more reason to innovate.
3. Banks with monopolistic power are expecting to make high profits, thus acquire higher franchise value, which increases prudent risk-taking behavior of banks. On the contrary competition destroys franchise value. The unti-competitive regulation, such as deposit rate ceiling may not be efficient in reducing the competition in banking sector. The only way to reduce competition in banking and enhance bank profits, is the restriction on entry in banking sector. (Keeley, 1990, Demsetz et al., 1996).
4. Fewer the number of bank greater the incentive for screening, and consequently higher the proportion of funds that is allocated efficiently to high quality enterprises (Nicola Cetorelli, 2001).
5. Few large banks are easier to monitor (Ward)
The opposing view claims that regulation is not necessary and gives the following argument:
1. Free entry reduces concentration and increases competition, which is beneficial because it eliminates inefficient banks and thus creates stability (Shleifer and Vishny, 1998)
2. Increases efficiency. Big banks, on the one hand, have less reason to improve their services. On the other hand, when only a few firms compete, they are likely to possess market power, charge higher prices and produce lower quantities. Opportunities for mutually beneficial exchange are missed, and this is not efficient. Worse, such firms may not compete, but instead form a cartel. In competitive markets firms have to survive and that leads to higher efficiency. (Ward)
3. Banks with monopolistic power charge higher loan interest rates to business and pay lower rate of return to depositors, thus reduce quantities for credit. Further, higher lending rates would produce the incentives of borrowers to take risk and thus increases the likelihood of failure (Pagano, 1993)
Noteworthy to mention restrictions on foreign bank entry separately, because they play big role in most of the countries. Several authors have addressed the potential benefits of foreign bank entry for the domestic economy:
1. Free foreign bank entry leads to better resource allocation and higher efficiency
(Levine, (1996), Walter and Gray (1983), and Gelb and Sagari (1990)).
2. Increases competition and thus, improve the quality and availability of financial services in the domestic financial market, enabling the application of more modern banking skills and technology, serve to stimulate the development of the underlying bank supervisory and legal framework, and enhance a country’s access to international capital (Levine (1996).
3. Since foreign bank entry can render national banking markets more competitive, thereby it can force domestic banks to start operating more efficiently.
If we discuss all positive and negative sides of regulation on entry, we may conclude that there is an optimal degree of concentration. Too concentrated banks are too big to fail and so seek risks; too competitive banks cannot make money safely and so seek risks. Some competition policy is then better than others.
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