Abstract Essays in Bank Competition and Lending
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ABSTRACT ESSAYS IN BANK COMPETITION AND LENDING BEHAVIOR Genuine Martin, Ph.D. Department of Economics Northern Illinois University, 2017 Carl Campbell III, Director This dissertation assesses the competitiveness of Tanzania’s banking sector using both structural and non-structural (industrial organization) approaches, assesses the predictors of banks’ lending behavior, and investigates the bank lending channel of monetary policy transmission process. The first and the second essays utilize bank-level panel data of commercial banks whereas the third employs aggregate time series data. My work contributes to understanding the underlying factors and processes which explain the nature of competition in the banking sector and the conduct of monetary policy in Tanzania. In the first essay, I use the dynamic regression model to test the hypotheses that the market power of banks in Tanzania leads to higher bank profits, by including the lag of the dependent variable among regressors to test the tendency of profits to persist over time, using the market share of banks to test the relative-market-power (RMP) hypothesis, and using concentration ratios to test the structure-conduct-performance (SCP) hypothesis. Using data drawn from twenty-six commercial banks during the 1998-2015 period, I establish from the results that the lag of the dependent variable, market share of banks, and industry concentration ratios (HHIs) have a positive and statistically significant effect on bank profit. These results support moderate persistence of bank profits over time, RMP and SCP hypotheses, as potential explanations of high bank profits. In the second essay, I also use the dynamic regression model to assess potential predictors of commercial banks’ lending behavior and the bank lending channel of monetary policy transmission process. Using quarterly panel data for thirty-one commercial banks for the 1998- 2015 period, I establish from the results that bank lending persists significantly over time, hence suggesting that some degree of relationship banking and lock-in-effect for lenders and borrowers exists. Although bank size and capital, and inflation rate are associated with higher bank lending, credit risk, private and foreign bank ownership, market power of banks, and the square of inflation rate, have a negative effect on lending. Results for the bank lending channel show that contractionary monetary policy (higher monetary policy indicators) is associated with higher bank lending, and this positive effect of contractionary monetary policy on bank lending is more pronounced in samples of all the banks and medium-sized banks that are more capitalized, in a sample of large banks with more liquidity and capital but with less assets, and in a sample of small banks with less size and capital. By drawing on a country-specific case of Tanzania, this essay is illuminating because results of studies of this nature differ across countries and regions, depending on the structure of the economy, financial sector development, institutional and regulatory environment. In Amidu (2014), determinants of bank lending are different across economic integrations (Economic Community of West African States [ECOWAS], the East African Community [EAC] and the Southern Africa Development Community [SADC]. In the third essay, I use the dynamic regression model (autoregressive process of order one), which empirically applies the theoretical seminal work of Panzar and Rosse (1987) to estimate an index of banking sector contestability, the H statistic, which is the sum of factor price elasticities of the reduced form revenue equation. Using time series data for the 1998-2015 period, the estimated H statistic of 0.57, characterizes Tanzania’s banking sector as monopolistic competitive, in which high industry concentration co-exists with considerable contestable pressure. Bank revenues persist moderately over time, whereby interest revenue generation is a key bank activity. Furthermore, the aftermath of the 2006 second-generation financial sector reforms is associated with improved banking industry competitiveness, based on the moving average estimates of the H statistics, and is associated with changes in the banks’ production functions, whereby banks substitute less funds (deposits) and physical capital, with more labor. These results are consistent with the dramatic decline in the interest rate spread and an increase in the proportion of labor costs. NORTHERN ILLINOIS UNIVERSITY DEKALB, ILLINOIS DECEMBER 2017 ESSAYS IN BANK COMPETITION AND LENDING BEHAVIOR BY GENUINE MARTIN © 2017 Genuine Martin A DISSERTATION SUBMITTED TO THE GRADUATE SCHOOL IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR THE DEGREE DOCTOR OF PHILOSOPHY DEPARTMENT OF ECONOMICS Doctoral Director: Carl Campbell III ACKNOWLEDGEMENTS I am greatly indebted to my advisor, Professor Carl Campbell III, for devoting his time to reading my essays tirelessly, for his support, and encouragement that made me consider the possibility of completing my doctorate studies within three years, instead of the usual five. I express my sincere gratitude to Professors Maria Ponomareva and Ai-Ru (Meg) Cheng for serving on my committee, and for their guidance and constructive comments. I am very grateful to Professor Jeremy Groves, for his administrative support as the Graduate Director in the Department of Economics, who supported me in every way to meet the graduate school requirements and deadlines timely. His support is one of a kind. I also thank Fulbright, the University of Dar es Salaam (UDSM) and the Department of Economics and Graduate School at the Northern Illinois University, for scholarship, assistantship and financial support during my entire study. As always, I am indebted to my mother Mary, the sweetest woman in my life, for her prayers and continuous inspiration and moral support, all the way from a small rural village in Tanzania, and my guardian Mzee Steve Moshi. All, for the greater glory of God. DEDICATION In memory of Ben Martin Paul Mtauli, with love TABLE OF CONTENTS Page LIST OF TABLES .......................................................................................................................... v LIST OF FIGURES ...................................................................................................................... vii Chapter 1. INTRODUCTION ...................................................................................................................... 1 1.1 Market Structure, Profit Persistence and Performance of Tanzanian Commercial Banks ... 1 1.2 Assessment of the Determinants of Commercial Banks’ Lending Behavior and the Monetary Policy Transmission Process in Tanzania .................................................................. 3 1.3 Assessment of the Tanzania’s Banking Industry Competitiveness using the Panzar-Rosse Approach ..................................................................................................................................... 5 1.4 Structure of the Dissertation ................................................................................................. 7 2. MARKET STRUCTURE, PROFIT PERSISTANCE AND PERFORMANCE OF TANZANIAN COMMERCIAL BANKS ...................................................................................... 8 2.1 Introduction ........................................................................................................................... 8 2.2 Related Literature................................................................................................................ 11 2.3 Methodology and Data ........................................................................................................ 17 2.4 Empirical Results ................................................................................................................ 25 2.5 Conclusion and Future Research ........................................................................................ 35 3. THE DETERMINANTS OF COMMERCIAL BANKS’ LENDING BEHAVIOR AND THE MONETARY POLICY TRANSMISSION PROCESS IN TANZANIA ..................................... 38 3.1 Introduction ......................................................................................................................... 38 3.2 Related Literature................................................................................................................ 43 3.3 Methodology ....................................................................................................................... 58 3.4 Empirical Results and Discussion ....................................................................................... 67 3.5 Conclusion and Future Research ........................................................................................ 78 4. ASSESSMENT OF THE TANZANIAN BANKING INDUSTRY COMPETITIVENESS USING THE PANZAR-ROSSE APPROACH ............................................................................ 84 4.1 Introduction ......................................................................................................................... 84 4.2 Related Literature................................................................................................................ 88 4.3 Methodology and Data ........................................................................................................ 94 4.4 Empirical Results and Discussion ..................................................................................... 107 4.5 Conclusion