Market Power of Ethiopian Banks: Evidence and Explanations
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Date
2012-06
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Addis Ababa University
Abstract
The measurement of the degree of competition in any economic sector is of great relevance in that the level of social welfare decreases as the market power of firms’ increases. In the specific case of the banking sector, the analysis of the social inefficiency associated with market power is even more important if we take into account the importance of the financial intermediation function in economic growth.
The Ethiopian banking sector is analyzed for evidence of market power by computing the Lerner Index of banks using annual data from 2002 to 2011. Using a model of oligopolistic conduct, we show that Ethiopian banks exercised market power in setting prices. The examination of the determinants of market power identifies the positive roles of operating efficiency and size. However, the results also indicate that inflation, elasticity of demand to loans and excessive size had a weakening effect on exercise of bank’s market power.
As far as the study is concerned, the National bank of Ethiopia does not enjoy the luxury of implementing available policy instruments to minimize the impact of market power on social welfare and economic growth because the main explanatory variables are bank specific. Instead, it should endeavour to create an enabling environment for contestability in the sector, for example continuing with the open policy of domestic equity participation by adopting friendly and rational regulations. In addition, foreign banks should also be allowed to operate as such entry will intensify competition and propagate efficiency gains across the banking market.
Key Words: Competition, monopoly power, social inefficiency, Lerner Index
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Keywords
Competition, monopoly power, social inefficiency, Lerner Index