Testing for Market Power in the Swedish Banking Oligopoly

The purpose of this paper is to examine the degree and art of competition in a domestic bank market. It is the first attempt to use the oligopoly model developed in Oxenstierna (1998) in empirical research. A quasi multi-product (loans and deposits) banking application of that paper’s basic game theoretic model is developed, allowing for asymmetries in cost levels and two different types of product differentiation. The model is then solved for different theoretical equilibria. The model has enough structure for direct use in the empirical application in this case in an analysis of competition in the Swedish bank oligopoly. All market parameters are derived from estimating n bank-specific demand equations and an aggregate market demand equation for each market. Since all behavioural equations are provided in the theoretical model there is no need for econometrical estimation of bank-level conduct. Results show that there was significant market power in both the loan market and the deposit market, although with a strongly time-varying pattern. The overall picture of conduct, is that pricing policies are less competitive in the deposit market. The economic cost level constitutes a bottom level for pricing policies in the loan market, and attempts to establish higher spreads are not sustainable in the long run. It was also possible to evaluate the conduct of individual banks. Finally, welfare losses to the society from noncompetitive pricing were calculated. They are around 1.1% of GDP as a yearly average during the sampling period (1989-97). The paper also analyses the empirical transmission of money market rates into loan and deposit rates, and finds evidence of significant stickiness mainly in the loan market. ___________________________________________________ * I thank Marcus Asplund for valuable comments, and Phil Molyneux for helpful discussions and help with data. I am also grateful to the Riksbank for help with data and to the Swedish Competition Authority for financial support.