Bank concentration and efficiency of commercial banks in vietnam

666 | ICUEH2017 Bank concentration and efficiency of commercial banks in Vietnam LE NGUYEN QUYNH HUONG University of Economics HCMC – quynh_huong@ueh.edu.vn NGUYEN HUU BINH University of Economics HCMC – huubinh_ais@ueh.edu.vn Abstract The relationship between bank concentration and bank efficiency remains a controversial topic This paper investigates to what degree bank concentration dampens or enhances the response of bank efficiency in Vietnam and vice versa This study applies Concentration Ratio (CR) and Herfindahl - Hirschman Index (HHI) as proxies of bank concentration, while efficiency scores are calculated by stochastic frontier approach (SFA) and data envelopment analysis (DEA) To test the Structure Conduct Performance (SCP) and Efficient Structure (ES) paradigm, the authors use Granger causality approach However, regarding the causality running from bank efficiency and bank concentration, the results are complex: we find the causality running from concentration to efficiency is weak, whereas efficiency Grangercaused negatively competition Over a relatively long time period, from 2007 to 2014, the more efficient commercial banks operated in the less concentrated market Keywords: Vietnam; bank concentration; efficiency; structure conduct performance Introduction In the process of integration into the world economy, Vietnam's financial market is under great pressure Strong competition among commercial banks would be a great opportunity for the banking sector if Vietnam domestic banks are more adaptable and operate more efficiently, especially under the Restructuring Plan Thus, operational efficiency becomes a vital part for the survival of a bank in the increasingly competitive environment The relationship between bank concentration and bank efficiency, especially in Vietnam, is open to doubt and highly ambiguous There are numerous studies testing for this relationship Some concentrate on the Structure Conduct Le Nguyen Quynh Huong & Nguyen Huu Binh| 667 Performance (SCP) paradigm (Bikker & Haaf, 2002a; Deltuvaitė, Vaškelaitis, & Pranckevičiūtė, 2015; T P T Nguyen & Nghiem, 2016), while others support the reverse relationship namely efficient structure hypothesis (ES), which considers that bank efficiency positively influence on market concentration (Punt & Van Rooij, 2003; Weill, 2004) Recently, this topic has received tremendous attention in Vietnam, and only three studies found hitherto (Chinh & Tiến, 2016; Huyền, 2016; Thơm & Thủy, 2016) Unfortunately, no study analyses simultaneously the relationship between bank concentration and efficiency by using Granger causality Thus, this is a noticeable research gap needed further investigation The purpose of this paper is to examine the relationship between bank concentration and efficiency by using the application of Granger causality method It also tests Structure Conduct Performance and Efficient Structure hypothesis The rest of the paper is structured as follow Section presents a brief overview of Vietnamese banking system Section contains the previous related literature Section describes the methodology and the data Section contains the empirical results while section gives conclusions and policy recommendations Overview of Vietnamese banking system According to the State Bank of Vietnam (SBV), the history of banking activities is divided into four stages, including critical periods: 1986 - 2001 (reforming from the mono-banking system into the two-tier banking system) and after 2011 (restructuring the Vietnamese banking system) The process of restructuring the banking system and clean-up bad debts has implemented drastically under Vietnam’s banking restructuring Scheme in 2011-2015 (Decision 254, 1/3/2012) and Non-performing debt settlement Scheme of credit institutions (Decision 843, 31/5/2013) These Schemes focus on some central goals, including controlling the weak credit institutions, bad debts, development of the banking system and to contribute significantly to macroeconomic stability, removing difficulties for production and business, promoting economic growth To sum up, the process of restructuring of Vietnam's banking system consists: • The privatisation of state-owned commercial banks • Increasing the financial scale and capacity: raising capital, acquisitions and mergers, expanding mobilisation 668 | ICUEH2017 • Improving asset quality, credit quality and reduce bad debt Vietnamese commercial banking system can be classified into main groups: (1) State-owned commercial bank, (2) Joint stock commercial bank, (3) Foreign commercial bank, and (4) Joint venture commercial bank Figure shows the number of commercial banks as well as Non-performing loans (NPLs) over the period of years It is noticed that State-owned banks and foreign banks still remained in number, while Joint stock commercial banks decreased their number from 40 in 2008 to 30 in 2014 According to Vietnam’s banking restructuring Scheme mentioned above, some weak banks (Joint-stock commercial banks) took actively and hospitably M&A with other leading banks resulted in the drop in the number of commercial banks from 52 in 2007 to 44 in 2014 For example, Vietnam Tin Nghia Bank together with SCB and First Bank of VN merged into SCB, Western Bank and PVFC consolidated in PVcombank, Habubank is acquired by SHB, etc Because of high NPLs in weak banks, merging with leading banks could be an efficient solution encouraged by SBV in order to strengthen and improve the competition of Vietnamese domestic banks NPLs figures shown in Figure followed an upward trend, from 2% (2007) to 4.55% (2013) After reaching a peak at 4.55% in 2013, NPLs decreased significantly to 3.25% It is doubtful that some banks could “cook the book”, deliberately failed to comply with regulations on debt classification and recorded bad debts in financial statements lower than actual However, some argue that 2014 is the first year Vietnam Asset Management Company (VAMC) bought bad debt from troubled banks and moved a considerable amount of NPLs out of banks’ financial statements (approximately 123 thousand billion VND, according to SBV – 23/12/2014) Number of banks Le Nguyen Quynh Huong & Nguyen Huu Binh| 669 State owned commercial bank Joint stock commercial bank Joint venture commercial bank Foreign commercial bank Non-performing loans Figure Number of Vietnamese banks and NPLs from 2007 to 2014 Source: Annual Statements of State Bank of Vietnam (SBV) Literature review This section reviews the theoretical and empirical results between bank concentration and efficiency There have been long theoretical debates about the relationship between market concentration and efficiency These debates dated back to three distinct hypotheses that reflect the opinions on this relationship Two hypothesis in the structural approach including the traditional Structure-Conduct-Performance (SCP) hypothesis, which is originated from the traditional industrial organisation literature, and the Efficient Structure (ES) hypothesis In which, SCP hypothesis argues the direct positive link between market concentration and profitability based on the presumption that banks in a high concentrated market can collude to earn higher profits resulting in efficiency (Bain, 1951, 1956) ES hypothesis, meanwhile, assumes a reverse causality that efficient banks are more profitable and gain market shares, resulting in a concentrated market In other words, the higher efficiency of market leads to the higher market concentration (Demsetz, 1973) The “quiet life” (QL) 670 | ICUEH2017 hypothesis developed by Hicks (1935), by contrast, supports a negative relationship between market concentration and performance Following this, firms with market concentration tend to make few efforts to maximise efficiency Because managers in these firms may have no motivation and enjoy the monopoly profit of a “quiet life”, and this may result in inefficient operation Based on these hypotheses, there were a numerous number of studies performed in the banking sector in many parts of the world Some of the studies are summarised in Table Table Authors Homma, Tsutsui, and Uchida (2014) Fu and Heffernan (2009) Lloyd-Williams, Molyneux, and Thornton (1994) Molyneux and Forbes (1995) Goldberg and Rai (1996) Coccorese and Pellecchia (2010) Al-Muharrami and Matthews (2009) Koetter and Vins (2008) Fang, Hasan, and Marton (2011) Berger and Hannan (1998) Casu and Girardone (2009) Ferreira (2013) Nguyen, Stewart (2013) Hypothesis tested Authors Zhang, Jiang, Qu, and Wang (2013) Celik and Kaplan (2016) As can be seen from the Table 1, there are differences in the results of empirical studies concerning the relationship between bank concentration and efficiency proposed by three hypotheses mentioned above This shows that the relationship between bank concentration and efficiency depends on the characteristics of each country and region This paper uses Granger causality to test simultaneously both SCP and ES in the case of Vietnam Methodology To test the Granger causality relationship between bank concentration and bank efficiency, this section explains the methodological framework and the data: how to measure bank concentration and bank efficiency, how to choose inputs and outputs from financial statements of commercial banks, and the Granger causality procedure 4.1 Bank concentration The market concentration is scaled from low to high, and in this regard, the market is catalogued into four cases: (1) perfect competition, (2) monopolistic competition, (3) oligopoly and (4) monopoly The market which is considered as perfect competition is addressed as low concentrated, and on the opposite side of the scale - the concentration of market which tends to monopoly is evaluated as high (Boďa, 2014) 672 | ICUEH2017 Market structures Perfect competition Low concentration concentration High There are a number of market concentration indicators based on the calculation of market shares Among other things, two standard and popular ways to measure concentration level are Concentration Ratio (CR) and Helfindhal-Hirschman Index (HHI) The other wellknown indicators of concentration ratio are the Coefficient of variation, the Hall-Tideman Index (HTI), and the Comprehensive industrial concentration index Table gives a brief overview of these concentration measures except for CR and HHI However, because of general consensus, data validation and straightforwardness, this paper use CRk and HHI to measure the concentration in Vietnamese banking market Technically, both CRk and HHI not require to rank and sort in descending order all banks based on their market shares The k bank concentration ratio The k Bank Concentration ratio is the simplest and required limited data measure of concentration Nevertheless, this measure only emphasises on kth leading banks while neglecting the small banks Moreover, there is no rule for determination of the value of k, so k can be chosen on an ad hoc basis (often, k = 3, 4, 5, 8) The Concentration ratio of k banks is calculated as: # CR# = where: S& is the market share of i th bank S& &'( Firstly, we test the stationarity of the series, using augmented Dickey-Fuller test Lags are included and the null hypothesis is non-stationary existing The decision of 682 | ICUEH2017 choosing whether random walk with drift or without drift is based on the shapes of the trend line graph in Figure Both variables Scale and jlms of each banks are adjusted by multiplying by their market shares in percentage, then name them as Scale-adjusted and jlms-adjusted .845 85 84 scalea 855 86 Figure Trend line of Scale-adjusted, jlms-adjusted, HHI, CR4 1000 1100 1200 1300 1400 hhi 2006 2006 Table ADF test Scale-a MacKinnon approximate p=value for Z(t) lag (0) lag (1) Table illustrates that only jlms-adjusted (jlms-a) is station while Scale-adjusted (Scale-a), CR4 and HHI are station with time lag Thus, we decide on lags for scale-a, jlms-a, cr4, hhi (1,0,1,1, respectively) Le Nguyen Quynh Huong & Nguyen Huu Binh| 683 Then we test endogeneity of all models to whether or not to apply GMM to robust the results We discover that all explanatory variables are exogenous variables, means Cov (X jt, ϑjt) = 0, with j is j-th model Whenever OLS estimators are as well as GMM estimators, no need to use GMM The results obtained from testing the hypotheses put forward to explain the SCP and ES relationship are presented in Table 6, ES hypothesis test, it is also clear that the bank efficiency of the previous year (first lags) has a negative and statistically significant influence on bank concentration, while the influence of the same year is not statistically significant Increasing in bank efficiency Granger-causes a fall in both HHI and CR4 index, meaning scale efficiency positively Granger-causes competition This results are consistent with findings of Ferreira (2013); T N Nguyen and Stewart (2013); Casu and Girardone (2009) and reject the ES hypothesis in Vietnam Based on the signs of regression coefficients, noticeably, this study makes an unambiguous conclusion that ES Hypothesis should be rejected in transition economy like Vietnam One possible explanation is that Vietnamese banking system is considered highly regulated and “over-protected” In a highly regulated and “overprotected” market, efficient banks compared to State owned banks (inefficient banks) hardly continue high profits because efficient banks cannot have advantages and create barriers to market entry The policy makers should notice that each policy intervention or interventionism could adversely affect the development of the banking system and distort the structure of the system Another explanation could be that the business strategies of large Vietnamese banks during this period were focused on raising capital, loans, assets, deposits, branch networks and reducing NPLs Thus, revenue, interest income and profit before tax were not the most propriety missions of banks (T N Nguyen & Stewart, 2013) Panels (b) and (d) in Table show that the first lags of competition are significantly (different from zero), indicating that competition at time t is influenced by previous year's competition With regard to the causality running from bank concentration (measured by CR4 and HHI) to DEA scale efficiency and SFA jlms, the results presented in the later Table are inconsistent and contradictory DEA-efficiency is affected positively by concentration and previous year’s efficiency, while there is a negative influence from concentration to SFA jlms However, this result is not significant, implying that concentration does not Granger cause to the efficiency of Vietnam’s banks Overall, the evidence for Vietnam commercial banks does not support either the ES or SCP hypothesis 684 | ICUEH2017 Table Granger test ES test dependent variable: Explanatory variables: a) Lag HHI, jlms-a Explanatory Explanatory Cons Granger test (Prob > F) Ho: no granger cause SCP test dependent variable: Explanatory variables: Explanatory Explanatory cons Granger test (Prob > F) Ho: no granger cause Conclusions and policy implications This paper employs Granger causality to examine the relationship between bank concentration and efficiency The data is collected from the consolidated accounting statements of 21 commercial banks in Vietnam from 2007 to 2014 To measure bank concentration, we opt to use two common approaches: Concentration Ratio (CR4) and Helfindhal-Hirschman Index (HHI) The results reveal that there is a decline of concentration ratio from 2008 to 2012, and then it rose slightly over the following two years It is apparent that the booming M&A in 2012-2014 results in the increase of bank concentration in these years In general, Vietnam's banking Le Nguyen Quynh Huong & Nguyen Huu Binh| 685 concentration is still ranked at a low level with high competition, however, the situation is expected to be reversed after Restructuring Plan of SBV ends in 2020 One must concede that the findings of low concentration of Vietnamese banking sector are “good message” for bank customers, but not offer any guidance in which directions the Vietnamese banking sector should be regulated in the future High competition could be considered as a threat for domestic banks, especially after the ASEAN Economic Community in 2015 (aggressive competition from ASEAN and Japanese banks into the domestic market) SBV can act only within the scope of its competence and try to maintain changes in the current level of concentration and endeavour to prevent unnecessary M&A that would contribute to lowering competition and increasing bank concentration For bank efficiency, we applied DEA and SFA estimation and found that most inefficient commercial banks are State-owned banks We believe that the SBV needs to strengthen the whole banking system by restructuring the State-owned banks into privatisation There is also a need to well-prepare for merger and acquisition procedure of some small and inefficient domestic banks when the bail-out sources are not only funded by SBV but also from foreign organizations The SBV should prepare for specific scenarios and management policies when Asian Development Bank (ADB) has announced a plan to cooperate with a Vietnamese company to buy one of the “VND banks” in 2017 Our empirical results not, in general, support either SCP and ES The regression models did not yield the reliable results due to the statistically insignificant regression coefficients and the reversed sign of them We also test endogeneity of all models to whether or not to apply GMM to robust the results Due to the fact that all explanatory variables are exogenous, there no need to apply GMM estimator We found that bank concentration was related negatively to bank efficiency and positively to previous year concentration Although according to ES, the banking industry will become more concentrated under competition conditions if some banks are more efficient, the results of this study are reversed Then, efficient banks cannot maintain competitive advantage and create barriers to entry partly because of the intervention of SBV through preferential monetary policies for the State-owned banks Therefore, we come up with a suggestion that the governmental regulation and intervention are inappropriate policies since they might impose penalties on efficient banks and discourage the proper functioning of the banking market mechanism Regarding SCP-test, however, control variables (market concentration, lag 1-year efficiency) are positive and insignificant This outcome is likely 686 | ICUEH2017 due to rigid regulatory rules governing banking activities and strict control over interest rates, which also prevented Stateowned banks (“big 4”/large bank) from enjoying monopoly profits, thereby ruling out any opportunity to opt for a market power Taken together, the findings of this study indicate that the Vietnamese banking sector data not provide a support either SCP or ES hypothesis, but consistent with those for China, European countries, Arab, Vietnam, etc found in previous work Hence our results suggest that the model might content a Restructuring Banking system-depending-variable During this phase, the “big 4” banks were State-owned banks with the special power, subsidised by the government to make loans to designated sectors and firms Moreover, SBV nominated State-owned banks to buy weak banks Thus, neither concentration nor efficiency significantly affected the profitability and competition advantage Le Nguyen Quynh Huong & Nguyen Huu Binh| 687 Appendix Appendix Other Operating dmu a Income ABB ACB AGR BIDV CTG EXM MB MEK MHB NCB OCB OCE PGB SAC SEA SHB SHI VCB VIB VID VPB a million VND 688 | ICUEH2017 Appendix HHI ESTIMATED CONCENTR HHI CR4 Aigner, D., Lovell, C A K., & Schmidt, P (1977) Formulation and estimation of stochastic frontier production function models Journal of 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According to Vietnam? ??s banking restructuring Scheme mentioned above, some weak banks (Joint-stock commercial banks) took actively and hospitably M&A with other leading banks resulted in the drop in the... restructuring of Vietnam' s banking system consists: • The privatisation of state-owned commercial banks • Increasing the financial scale and capacity: raising capital, acquisitions and mergers, expanding