Marginal costs: A comparison between Chapter 3 and 4

Figures 4.1 and 4.2 depict the general trend in marginal costs of three bank groups from year 1997 to year 2012 based on the model of Chapter 3 and the model of this chapter, respectively. The classification of these three groups is the same as that used in Chapter 3, as follows. According to the market shares, as measured by

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banks loans in 2012, all of the banks are divided into three groups. I then use the top three banks (i.e. HSBC, Bank of China and Hang Seng) to represent large banks, three middle banks (i.e. Nanyang Commercial Bank, Wing Hang and CITIC) to express the middle banks, and three bottom banks (i.e. Fubon, Chiyu and Public) to represent the small banks. Although in general the marginal costs obtained using conjectural variation approach are relatively smaller than that using the model to estimate switching costs, there is not much difference in the overall pattern between the two models. Therefore, the results obtained in this chapter are robust.

Figure 4.1 Marginal costs of three bank groups in Chapter 3 using non- linear 3SLS 1998 2000 2002 2004 2006 2008 2010 2012 0.00 0.02 0.04 0.06 0.08 0.10 0.12 0.14

MC

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Figure 4.2 Marginal costs of three bank groups using non-linear 3SLS approach 1998 2000 2002 2004 2006 2008 2010 2012 0.00 0.02 0.04 0.06 0.08

MC

Figure 4.3 provides the price cost margin of three bank groups for the period 1997 to 2012. For the entire sample, the values of price cost margin range from 0.68% to 6.50%. The average price cost margin based on the entire sample is 3.27%. Compare with the case of Italy (Coccorese, 2005) and Turkish (Aydemir, 2013), the price cost margin in Hong Kong is much smaller.

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Figure 4.3 Price cost margin

1998 2000 2002 2004 2006 2008 2010 2012 0.00 0.01 0.02 0.03 0.04 0.05 0.06

P

CM

4.4.4 Summary

This chapter measures the degree of collusion and the nature of competitive condition among the 18 Hong Kong banks during 1997 to 2012 using a conjectural variation approach. The empirical results suggest that the bank behaviour is coherent with a Nash- Bertrand equilibrium in the Hong Kong bank loans market in which the conjectural variation parameter λ is insignificant at 0.3452 using a non-linear 3SLS approach. In addition, there is no significant evidence of collusion on pricing in Hong Kong bank loans market. As a robustness test, using the GMM approach the conjectural variation parameter is positive and

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insignificant at 0.6001, which is relatively larger than using non-linear 3SLS approach. These findings are consistent with Wong et al. (2007) and Ho (2010). The trend of marginal costs and price-cost margins of banks presented in this section is consistent with the results in Chapter 3.

4.5 Conclusion

By using the conjectural variation approach, this chapter measured the degree of collusion and competitive condition among the 18 banks incorporated in Hong Kong during 1997 to 2012. The evidence from the empirical results suggests that Hong Kong banking is characterized by oligopolistic competition and the bank behaviour is coherent with a Nash- Bertrand equilibrium in which the conjectural variation parameter is insignificant at 0.3452 using a non-linear 3SLS approach while the number is 0.6001 using a GMM approach. In addition, the pattern of marginal costs and price cost margins is consistent with that of Chapter 3. Therefore, the empirical results are robust.

Hong Kong banks face fierce competition. The Hong Kong government is committed to promote competition in order to enhance economic efficiency and free trade, and thereby also improve consumer welfare. Before 1997, there was no competition policy in Hong Kong. After the Competition Policy Advisory Group (COMPAG), which was supervised by the Financial Secretary, was established in December 1997, the first Statement on Competition Policy was promulgated in May 1998 to provide a policy framework to guide the market and to promote

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competition. From the view of the consumer, the experience of competition policy in the Hong Kong banking industry is that it leads to lower prices, product innovation, more choices and improved services. But from the view of the banks, this policy also increases the competition in the banking market. Many strategies have been adopted by banks to beat the increasing level of competition. For example, they may increase their share in the mortgage market while some banks offer cast rebates to mortgage borrowers up to 8%. Since the interest-earning business is becoming more difficult, banks are increasingly relying on non-interest earning business, such as insurance, stock transactions, bonds sale.

Shanghai’s new free-trade zone (FTZ), which launched on September 2013, may also bring competitive pressure to bear on the Hong Kong banking industry. Although there is no immediate competition from the FTZ, Hong Kong banks should not relax. Over the past few decades, Hong Kong has enjoyed considerable benefits as a gateway for foreign investors wanting to invest in mainland China. Following the launch of the Hong Kong-like free trade area in Shanghai, Hong Kong will no longer be able to maintain the same status as a gateway to the Mainland and, therefore, Hong Kong banks should introduce new services and products to compete in this rapidly evolving environment.

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