Competition and bank profitability

Abstract

By issuing Indonesian Banking Architecture in 2004, the central bank of Indonesia has encouraged banking sector to consolidate. The aim of merger among others is to increase bank economies of scale. This study tries to look at the impact of merger bank on the bank performance by implementing structure conduct and performance hypothesis. Merger bank affects market structure. According to structure conduct and performance hypothesis, market structure affects bank behavior as well as bank performance. The result of this study suggests that an increase in market concentration causes a decrease in price. It shows that merger increase economies of scale so that bank can offer lower price. A decrease in price brings down bank profitability. Concentration ratio also can be used as competition measurement. It is known as a structural measure of competition. Using the structural measure, a lower competition that is shown by higher concentration ratio is associated with lower profitability. This research also analyses the relationship between competition and bank profitability using Lerner index as a non-structural measure of competition. The non-structural measure of competition shows that lower competition is associated with higher profitability. Hence, the structural measure of competition creates different result from the non-structural measure of competition.