Competition between Banks

There has been an intensive discussion about the key factors in the banking competition, and many factors have been associated with a successful banking. According to a survey (Heffernan 2005: 60) where bank managers were interviewed, there are six characters considered important to the competitiveness of a financial centre. The scores beside each attribute are based on a scale of 1 (unimportant) to 5 (very important).

- Skilled labor: 4.29

- Competent regulation: 4.01

- Favourable tax regime: 3.88 - Responsive government: 3.84 - A “light” regulatory touch: 3.54 - Attractive living/working environment: 3.50

According to the survey results, the bank managers see skilled labour clearly as the most important factor behind successful banking. Also the macroeconomic environment is seen to have a significant effect on bank performance. All in all, the key factors were quite obvious and the results provided no surprise. Though, it should be noted that de-spite the reduction of the personnel, which has been the trend also in banking as well in many other branches, the management still sees the employees as the most important factor behind success.

Financial deregulation, allowing the new entry of more and more banks, has made mod-ern banking a very competitive business. Banks compete with one another both in the interest rates they offer to attract deposits and in the interest rates they charge borrowers for loans. The interest rate spread is the gap between the interest rate a bank pays on de-posits and the rate it charges for loans. The spread covers the cost of providing banking services. When spreads exceed this amount, they generate profits for banks. Profits can be seen as a signal for new banks to enter, which tends to compete away spreads. With more banks, interest rates on bank loans fall. Increased competition for deposits also raises interest rates paid to depositors. Both of these effects reduce the spread and so also the profits of the banks. (Begg, Fischer & Dornbusch 2000: 387.)

Equilibrium in the banking industry occurs at the point at which it is not worth attract-ing any more deposits in order to make more loans. In a perfectly competitive industry, any supernormal profits are competed away eventually by free entry. Although banking branch is regulated more loosely than before, the regulation still exists. Moreover, there are substantial scale economies in banking, and competition is therefore imperfect. For

both of these reasons, equilibrium profit margins in banking are usually positive. (Begg et al. 2000: 387.)

Adapting modern technology has been an important tool in the banking competition during the past two decades. Internet and telephone banking have become popular and the majority of the customers take care of their daily banking via these channels. Once the systems have been developed and set up, it is in the interest of the banks to get the user volumes high in order to decrease the personnel and office related costs. ATM technology is known to reduce banks’ operating costs, but if the customers access the machine more frequently than they would visit the branch, the cost savings might be lower than expected. Banks also may find that electronic delivery methods decrease their ability to cross-sell other financial products, which leads to lowering of the in-come. The competition in banking seems to be a complex issue and therefore investigat-ing the possibilities and threats carefully before makinvestigat-ing strategies is extremely impor-tant. (Heffernan 2005: 473–474.)

As mentioned in the introduction, there has been a rising trend of mergers and acquisi-tions (M&A) in banking. They are seen as a usable method to improve efficiency in strengthening competition. In the global economy, there have been two waves of con-solidation identified, in 1987–1990 and 1997–2000. In the first wave, 63 % of M&As were in the manufacturing sector, 32 % in the tertiary or services sector, and 5 % in the primary sector. In the second wave, 1997–2000 the majority, 64 % of M&As were in services and 35 % in manufacturing. In both periods, within the service industry, a good proportion of the M&As were among financial institutions, especially between banks.

(Heffernan 2005: 517.)

The reasons for mergers and acquisitions are divided into three categories. The first is stockholder wealth maximization goals. If mergers lead to greater scale/scope econo-mies and improved cost/profit X-efficiencies, the sector as a whole should become more efficient and create value, all of which benefits stockholders. The second category is managerial self-interest: managers might see mergers as a way of enhancing or defend-ing their personal power and status. In the third category are a number of miscellaneous

factors that create an environment favorable to M&As. They include changes in the structure of the banking sector, such as increased competition from non-bank competi-tors. In Europe, the Banking and Investment Services Directives and the introduction of the euro have encouraged greater integration of EU markets. Another factor is techno-logical change, which has affected cost and profit X-efficiency both by encouraging more revenue earning financial innovations and cutting costs, such as the delivery of retail banking services. It is estimated that IT accounts for 15–20 % of total bank costs, and the percent is growing constantly. Mergers can help control these costs and improve IT systems, and therefore lead into rising efficiency figures. (Heffernan 2005: 519–520.)