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Bank efficiency, market structure and strategic interaction: Evidence from Vietnam

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Highlights

  • The study argues that efficient banks compete the market to grow, and become more responsive to their rivals’ strategies.

  • The study finds the positive relationship between efficiency and strategic interaction.

  • The study finds that the impact of efficiency on strategic interaction is stronger for banks with lower growth.

Abstract

This study investigates the impacts of Vietnamese banks’ efficiency on the strategic interactions with their rivals. The study argues that efficient banks will compete the market to grow, and then become more responsive to the strategies from their rivals. The study extends the Efficiency Structure theory to capture the behaviours of banks after the evolvement of market structure as the result of efficiency improvement. The study further argues that the speed of growth plays a key role in moderating the relationship between efficiency and strategic interaction. The study finds evidence that the impact of efficiency on strategic interaction is stronger at the lower level of growth.

Introduction

How the market structure evolves as efficiency improves has been long discussed, yet remained controversial. Two competing strands of literature, namely, efficiency structure theory (ES) and structure conduct performance theory (SCP), predict opposite directions for market structure evolvement. The former posits the roles of efficiency in altering market structure (Demsetz, 1973), the latter views efficiency as the results of the structure change (Bain, 1951, 1956). Recently, Bayar et al. (2018) bring up the argument by providing new evidence that strategic interaction negatively affects firm efficiency, and this impact is stronger (weaker) with strategic substitutes (strategic complements). Strategic interaction is defined as a firm’s reaction to price and/or quantity change by its competitors (Bayar et al., 2018). One firm’s aggressiveness is decreasing (increasing) with its rival’s debt if the firms’ strategies are substitutes (complements) (Lyandres, 2006). As strategic interaction is one of the characteristics of market structure, the finding from Bayar et al. (2018) supports SCP theory. Nevertheless, the literature largely ignores how efficiency may inversely affect strategic interaction, which is the gap our study would like to fill in. Our study views strategic interaction from the lense of ES theory and argues that firms’ efficiency leads to growth which, in turn, guides firms’ behaviours in interaction with their rivals. The moderating role of growth in the relationship between efficiency and strategic interaction is demonstrated through the asymmetric behaviours of efficiency to strategic interaction in different regimes of growth, i.e. low growth versus high growth. This is in line with the argument that efficient firms defeat the competition and grow (Homma et al., 2014). By doing this, the study extends the ES theory emphasizing the importance of efficiency on market structure manifested through strategic interaction.

The banking industry of Vietnam provides an ideal context to examine the impact of efficiency on strategic interaction. This is because the Vietnamese banking industry is highly regulated, where the State Bank of Vietnam (SBV - the central bank of Vietnam) sets the target on the number of banks, and hence, takes control on the rigorous approval process for entering, exiting, and merging of banks in the market1 . Therefore, in this context, the strategic interaction, rather the number of banks, can arguably better capture the evolvement of the market structure. In addition, the Vietnamese banking industry has become increasing competitive after joining the World Trade Organization in 2007. In the context of a transitioning economy, it is interesting to see how banks strategically interact with their rivals when their efficiency improves.

The study finds the positive relationship between efficiency and strategic interaction. In other words, as banks’ efficiency improves, they tend to be more active in strategic interaction with their rivals. Moreover, we provide evidence that the impact of efficiency on strategic interaction is stronger for banks with lower growth. The findings of this study are robust to different measure of bank market structure. Our study contributes to the literature on three fronts. First, the study extends the ES theory by examining the impact of bank efficiency on strategic interaction, which remains a gap in the literature. Second, the study sheds light on banking strategic interaction in the context where the number of banks is set and regulated by the government, leaving the reaction to rivals’ moves an interesting tool shaping market structure. Third, the study examines the asymmetric impacts of efficiency on strategic interaction in two regimes of bank growth, i.e. low versus high growth.

The remainder of this study has a following structure. Section 2 provides a brief overview of the Vietnamese banking system, reviews the literature and develops the hypotheses. Section 3 presents data collection and econometric models. Section 4 discusses the main estimation results and robustness tests. Finally, section 5 concludes this study.

Section snippets

Overview of vietnamese banking system

Vietnamese two-tier banking system consisting of four state-owned banks, joint stock commercial banks, joint venture commercial banks and foreign banks, has been undergoing the process restructuring to tackle bad debt problem. Since 2011, SBV has dramatically enforced the privatization of state-owned commercial banks, M&A of weak banks, and improving asset quality. M&A has been considered as an effective method to reduce non-performing loans (NPL) and strengthen the competition of the banking

Measurement of strategic interaction

We follow the studies of Sundaram et al. (1996); Lyandres (2006) and Bayar et al. (2018) in constructing the Competitive Strategy Measure (CSM) to proxy for strategy interaction which captures the correlation between the responsiveness of a firm’s profits with respect to changes in its rivals’ actions. Firms may respond to the competition with strategic complements or strategic substitutes (Bayar et al., 2018). With strategic complement, firms lower their prices in price competition, increase

Regression results and discussions

The 3SLS regression results for Eqs. 6,7 and 8 are presented in Tables 3,4 and 5. The SGMM regression results are reported in Table 6. In Table 3, Efficiency has a significant positive coefficient across 4 regressions with different measurements of Efficiency and Growth. This finding is consistent with the studies of Homma et al. (2012, 2014) and Khan et al. (2017). The result confirms our Hypothesis 1 that efficient banks subsequently grow and become bigger, and therefore, provides an

Conclusions

During the past 10 years, the Vietnamese banking industry has been growing fast and become increasingly competitive, motivating commercial banks to improve efficiency. This context enquires the study on the impacts of efficiency on strategic interaction. This study extends ES theory from the well-established casual impacts of efficiency on growth and consequently on market power, to the strategic interaction of efficient banks heterogeneously to the speed of growth. Employing 3SLS and SGMM

Declarations of Competing Interest

None.

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