competitiveness comparison islamic and conventional banks
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The Competitiveness Comparison Between Islamic Banks and Conventional Banks : Case of Indonesian Banking System
Presenter: Cupian (G1211025)
Supervisor : Dr. Muhammad Abduh
Ph.D Colloquium
Institute of Islamic Banking and Finance
International Islamic University Malaysia
November 2nd-3rd, 2014
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Outline
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Introduction
Problem Statement
Research Objective
Significance of the Study
Theoretical Framework
Methodology
Expected results/findings
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Banking competition has escalated over the past couple decades.Large financial institutions are strategically penetrating new marketsand try to offer a diverse spectrum of products and services tostrengthen their existence and boost their profitability. Among suchdevelopments is the expansion of Islamic banking since seventies,and its growing recognition as a viable mode of financing.
The recent global financial crisis severely hits the banking system ofseveral countries in the world and forces government to intervene inthe financial sector. All these events can bring a change inconcentration and competition in the banking systems.
The competitive environment of the banking system in Indonesia hasexperienced several changes in recent decades. The deregulation offinancial services in Indonesia allows banks to freely establishbranches and provide financial services throughout this country.
INTRODUCTION
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Problem Statement 9 Ap
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The deregulation of financial services in Indonesiaallowing banks to freely establish branches and providefinancial services can bring a change in concentration andcompetition in the banking systems.
the recent global financial crisis has severely hit theIndonesian banking system forces government tointervene in the financial sector and it could have animpact on the competitiveness of the system
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Research Objectives 9 A
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Empirically assessment of the competitive structure of the Indonesia banking system, both Islamic and conventional.
Investigation on an implication of the deregulation of financial services in Indonesia and the recent global financial crisis on the competitiveness of Indonesian banking system.
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Research Questions
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Q1:
What are the competitive structure of the Indonesia banking system both conventional and Islamic over the period 2006-2013?
What are the impact of input prices of deposit, physical capital and labor on the revenue of Islamic and conventional banks?
Q2:
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Research Questions
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What are the impact of total asset and equity ratio on the revenue of Islamic and conventional banks?
Q3:
What are the impact of efficiency on performance increases as the market becomes more competitive?
Q4:
What are the impact of total asset and equity ratio on the revenue of Islamic and conventional banks?
Q5:
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Significance of the study
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the results of this study may help bank managers determine the key success (or failure) factors of Islamic and conventional banks in the competitive market .
Knowledge gained from the study will provide government with information about how to make a financial policy which can create a competitive market in the banking sector.
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Market Structure
Monopoly
Oligopoly
Monopolistic Competition and
Perfect Competition.
Dual Banking Sector
Islamic Banks
Conventional Banks
Banking System Stability
The empirical analysis of the link between competition
and profitability of the banking system
Assessment the competitive structure of the
Indonesia banking system
the impact of input prices of deposit, physical
capital and labor on the revenue of Islamic
and conventional banks
Financial Deregulation and Financial
Crisis and Technological advance
1. H statistic of the Panzar-Rosse model
2. ordinary least square (OLS) and fixed effects(FE)
estimators
The deregulation of financial services in Indonesia, technological
advancement and the recent global financial crisis on the
competitiveness of the system.
the estimation of the Boone indicator pre and post financial
crisis
identify a change in the degree of competition
Market concentration and competition
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Efficiency
Profitability
Performance
Boone indicator
translog total cost function
seemingly unrelated regression
The overall Research Framework
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Literature Review
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Differences between Islamic and conventional bank
SCP and ES Theory
Studies on banking using Panzar Rosse Model
Studies on banking using Boone Indicator Model
Studies on banking in Indonesian Banking System
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The conventional bank operation is to purchase transactionsdeposits from the depositors at a low interest rate, then allocatethose funds to the households and firms at a higher interest rate,earning an interest spread based on its competitive advantage.Meanwhile, Islamic banking considered as a different bankingstream as it prohibits interest and replaces with a profit share.Moreover, another principle of an Islamic bank is the avoidanceof economic activities involving oppression.
(Santos ,2000)
Differences between Islamic and Conventional Bank
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The structure-conduct-performance (SCP) hypothesis and the efficient-structure (ES) hypothesis 9 A
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The SCP paradigm assumes that in concentrated markets, banks caneasily arrange collusive agreement and exercise market power.Empirically, a positive relationship between profitability and marketconcentration indicates that the market is less competitive. The EShypothesis on the other hand asserts that the positive relationshipbetween profit and concentration in concentrated markets could resultfrom the banks efficiency gains (cost advantage) contrary to thecollusive behavior. (Demsetz, 1974)
Under the ES hypothesis the positive statistical relation betweenprofitability and industry concentration could be explained by efficiencygains of banks. Empirical evidences support both hypotheses. Smirlock(1985) finds evidence in favour of the ES hypothesis using U.S. banks.Berger (1995) also finds that the ES hypothesis holds in the U.S.banking system. In contrast, Goddard et al. (2001) find evidence infavour of the SCP paradigm for European banking systems.
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Authors Countries Periods Results
Shaffer (1982) New York (USA) monopolistic competition
Casu and Girardone (2006) European Union countries 1997-2003. monopolistic competition
Molyneux et al. (1994) EU countries 1986-1989 Banks in France,
Germany, Spain and the
UK operate under
monopolistic competition
and the monopoly for
Italy.
Nathan and Neave (1989) Canada 1982-1984 perfect competition for
1982 and monopolistic
competition for 1983 and
1984
Vesala (1995) Finland 1985-1992 monopolistic competition
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Studies on banking using Panzar Rosse Model
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Studies on banking using Boone Indicator Model
Authors Countries Periods Results
Leuvensteijn et al.
(2007)
France, Germany, Italy,
the Netherlands, Spain,
the UK, the U.S. and
Japan.
1994-2004 U.S. has the most competitive loan market.
In the EU, German and Spain were found to have a competitive loan market.
commercial banks to operate under a more competitive environment than savings banks.
Tabak et al. (2011) 10 Latin American
countries banking
systems
Schaeck and Cihak
(2008, 2010)
European countries and
rural U.S. banks
Leuvensteijn et al.
(2008)
eight European countries
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Authors Periods Method Results
Gamaginta, Rokhim, (2010) 2004 - 2009 Z-score
indicator. Using
the parametric
statistical t-test,
The Islamic banks in
general have a lower
degree of stability
compared to
conventional ones the
Widyastuti,
Armanto, (2012)
2001 - 2006 Panzar and
Rosse
The competition in
banking
decreased after the
introduction of API,
with a large tendency to
monopoly or collusive
oligopoly
Studies on banking in Indonesian Banking System
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Scope and Limitation Study
This study focuses on the Islamic and Conventional banking sector in Indonesia with the observation period of 2006 -2013. The number of commercial banks was 88 commercial banks including 75 conventional banks and 13 Islamic banks which are treated equally as individual bank separated from their holding.
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Methodology
The non-structural approach
The Panzar-Rosse Model
Relative Profit Differences (The Boone Indicator)
Data analysis
variables
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The Panzer-Rosse model
The method attempts to infer the competitive
structure of a market by observing the response of a
banks equilibrium revenues to changes in cost of production.
The PR approach introduces H-Statistic, which is the sum of the elasticities ofbank revenue function with
respect to input prices
The method attempts to infer the competitive structure of a market by observing the response of a banks equilibrium revenues to changes in cost of production. The PR approach introduces H-Statistic, which is the sum of the elasticities ofbank revenue function with respect to input prices
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The rejection of the null hypothesis H < 0 rules out
the monopoly market structure
the rejection of both H < 0 and H = 1 the (but not
the H < 1 ) hypothesis indicates monopolistic
competition.
the rejection the H < 1 hypothesis, it indicates
perfect competition.
This interpretation is valid under the assumption that the
observations are in the long-run equilibrium (Nathan & Neave,
1989).
Empirical Application
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In the econometric analysis this paper estimates the H-statistic from the following log-linear reduced-form bank revenue equation for a panel dataset:
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Variable Definition
Total Revenue (TR) Total interest and dividend income plus non-interest operating income.
Total Cost (TC) Total operating expenses. It includes interest expenses, personnel expenses, and other operating
expenses.
Gross Interest Income (GII) *
)
Interest income on loans, other interest income, and dividend income.
Return on Assets (ROA) The ratio of before-tax profit to total assets. It captures all sources of income.
Price of deposits (W1) Ratio of interest expenses to total deposit and short-term funding (Current accounts, saving accounts,
time deposits, interbank deposits and alternative funding sources such as securities). It is a proxy for
the unit price of borrowing funds.
Price of physical capital (W2) Ratio of depreciation expenses and administrative expenses to total assets. Administrative expenses
include such as advertisement, security, information technology, and insurance expenses. The
variable is used as a proxy for the unit price of physical capital.
Price of labor (W3) Ratio of personnel expenses to total assets. Personnel expenses include wages and salaries, and other
staff-related expenses. It is used as a proxy for the unit price of labor.
Marginal cost (MC) It is the cost of producing one more unit of output. It is calculated by estimating a separate cost
function (7).
Loans ratio (Z1) Ratio of net loans to total assets. Net loan is calculated as gross loans minus provision for non-
performing loans. The variable is used to capture risk preference.
Total assets (Z2) It is the sum of the value of equity and liability. The variable is used to capture possible scale
economy.
Equity ratio (Z3) Ratio of equity to total assets. It captures the impact of leverage.
Output (q) It is the total earning assets. It includes loans, securities, insurance assets and investments in property.
The variable is used as a proxy for bank level output
*) For Islamic banks, the category of loans is substituted by financing activities and interest revenues are called financing revenues. Similarly, the interest expense item is labeled financing expenses.
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Data Analysis
The research methodology will be started by collecting the required data from Central Bank of Indonesia database. The data are publicly available in the quartally published Balance Sheet accounts and Income Statements of individual banks. The sample consists of 88 commercial banks including 75 conventional banks and 13 Islamic banks operating in Indonesia and they are treated equally as individual bank separated from their holding.
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Collecting Secondary Data
Data of Islamic Banks and Conventional Banks
being separated
Process by Regression Model
analyzed using the Panzar-Rosse (PR)
model and
the Boone indicator model
Summary
Procedure
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References
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Bikker, J.A., Haaf, K. (2002): Measures of competition and concentration in the banking industry: A review of the literature, Economic and Financial
Modelling9, 53-98.
Boone, J. (2008): A new way to measure competition,Economic Journal, Vol. 118, 1245-1261.
Brissimis, S.N., and Delis, M.D. (2011): Bank-level estimates of market power,European Journal of Operational Research, 212, 508517.
Casu, B., and Girardone, C. (2006): Bank competition, concentration and efficiency in the single European Market, The Manchester Scholl, Vol. 74, 4,
441-468.
Leuvensteijn, M., Bikker, J.A., van Rixtel, A. & Kok-Sorensen, C. (2007): A new approach to measuring competition in the loan markets of the euro area,
Working Paper No. 0768.
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Leuvensteijn, M., Bikker, J.A., van Rixtel, A. & Kok-Sorensen, C. (2008): Impact
of Bank Competition on the Interest Rate pass-Through in The Euro
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Molyneux, P., Lioyd-Willimas, D. M. and Thornton, J. (1994): Market structure
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576594. Panzar, J. and J. Rosse (1987): Testing for Monopoly Equilibrium, Journal of Industrial Economics, Vol. 35, 44356. Schaeck, K. and Cihak, M. (2008):How does competition affect efficiency and
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working paper series No. 932.
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