THE SCINTILLA

POST CRISIS STUDY OF

THE UK BANKING
SYSTEM using the Rose
and Panzar H statistic
-Studies in New Empirical Industrial Organization
Subhrodip Sengupta*
1/1/2015

*Professional Tutor and Quant Coach, can be

reached at subhrodipsengupta@gmail.com
No redistributions from this paper is permitted
except upon written approval.
Rights of commons asserted.

We explore the empirical prowess of H statistic method and its power in exhibiting
Oligopolistic/monopolistic pricing in small panels with missing observations by studying the
Post crisis evolution of the banking industry over the period of 7 years. This is a toy
example, meant for academic writing, and with no implicit or expressed warranty. It is
strongly suggested to read the original literature, and this paper strongly before jumping to
conclusions.

Contents
1. INTRODUCTION ..................................................................................................... 1
2. Theoretical aspects ..................................................................................................... 1
Table 1: Herfindahl- Hirshman Index computed for the relevant period. ................ 2
Table 2: Post Vs. Pre: Comparison with British Bankers association data up to
2002............................................................................................................................ 2
A brief overview of the Rose Panzar Statistic:........................................................... 3
3. Data and Methods ...................................................................................................... 4
Table 3a. Interpreting the Panzar-Rose H-statistic ................................................... 4
Table 3b. Interpreting the Panzar-Rose H-statistic (contd.) ..................................... 5
4. RESULTS .................................................................................................................. 5
Equation for Competitive Equilibrium (Results of regression eqn. 1)....................... 5
Equation for Equilibrium (Results of regression eqn. 2) ........................................... 7
5. Conclusion and Further Ideas .................................................................................... 8
Code for Computing the HerfindahlHirschman Indices: ......................................... 9
Code for computing Competitive Equilibrium .......................................................... 9
Bibliography .................................................................................................................. 9

1. INTRODUCTION
Competition in the Banking sector has far reaching consequences over other sectors,
whose survival is crucial on loans. It is easy to see in case of variance on returns, and
low covariance among firms, competing for sector, a monopoly in business financing
leads to monopolistic pricing in various sectors, eg. Telecom Industry Auctions
How (Not) to Run Auctions:the European 3G Telecom Auctions2002.
As a consequence the evolution of competitive structure in the retail banking sector
gains more substance, although it is interesting to motivate the study in its own merit,
considering interest rates as prices. To do the analysis, following Competitive
conditions among the major British banks2007, RossePanzar methodology is
explored on both Gross Earnings and Core Earnings of aggregated Bank Data in UK.
Finally we also compare results from the classical concentration ratio approach:
HerfindahlHirschman Indices.
Another reason to carry out this study is to evaluate the post-crisis evolution of the
banking sector since 2007.

2. Theoretical aspects
The U.S. Department of Justice considers a market with a Herfindahl Hirshman
Indices of less than 1,000 to be a competitive marketplace; a result of 1,000-1,800 to
be a moderately concentrated marketplace; and a result of 1,800 or greater to be a
highly concentrated marketplace. The Table below shows the Herfindahl-Hirshman
Indices computed for each year.
1

Table 1: Herfindahl- Hirshman Index computed for the relevant period.

Year
2007
2008
2009
2010
2011
2012
2013

Herfindahl
Hirschman
Indices
2191
2172
2121
2077
2049
2064
2042

This motivates the discussion into banking as a highly concentrated market.

Nevertheless, a few acquisitions and sell outs have been carried out, attributed to the
economic slump, namely, disinvestments of Lloyds Banking Group Plc and The
Royal Bank of Scotland Group Plc have happened in late 2012-2013, and can be
reflected in falling indices. The code used to generate the table in Eviews can be
found in Appendix A.
Conduct in a banking duopoly1994; Financial Dependence, Banking Sector
Competition,and Economic Growth2005find conduct that is much more
competitive than the market structure, by concentration ratio like HHI would suggest,
and much more market power than the market structure would suggest, respectively,
implying that HHI can poorly reflect market power. This holds in the current, postcrisis evaluation, and demands a more thorough model based finding.
To present a more scientific introspection, however the Roze-Panzar methodology is
adapted. Both the procedure suffer from a serious lacuna namely, aggregation of
different product markets. Housing societies are treated same as banks. Some
products are more competitive than others. Following How do UK financial
institutions really price their products? Journal of Banking & Finance2001, Net
Interest Income as a good proxy for market share, although banks do price their
products differently, and if the product mix varies, market share is poorly aggregated
by Net Interest Income. Cournot type behaviour was evident in the credit card market
as interest rate setting was sensitive to the number of suppliers, while mortgage rate
seemed more competitive. Non-Interest Income however displayed Price
Discrimination, and hence is exclude from our analysis.

Table 2: Post Vs. Pre: Comparison with British Bankers association data up to
2002
Year/measure
1986
1991
1996
2002

HHI
1428.470
1423.817
1051.831
1249.696

In the UK, it is widely believed that the Banking crisis had similar effects that the
collapse of Lehman Brothers had on the US banking sector. Faced with negative
market assessments and a crisis of confidence among peer institutions, many banks
2

depend strongly on central bank funding. Amidst major financial restructuring of the
retail banking industry, new empirical industrial organization which assesses
deviations between observed and marginal cost pricing, without explicitly using any
market structure indictor, but includes a Bank Specific variable becomes imperative.
We thus motivate our study with two aspects, higher conventional indices, as a result
of crisis (The fact that some bigger institutions survived, simply because they were
too big to fail), and decreasing equity value of banking institution, staggering
revenue and low Revenue Growth.

Figure: Staggering Prices in economy.

A brief overview of the Rose Panzar Statistic:

First, at the bank level, profit is maximized where marginal revenue is equal to
marginal cost:
Rli is the marginal revenue function, Cli is marginal cost function, yi is the output of
bank i, is the number of banks, and qi consist of exogenous variables having
bank-specific impact revenue and cost functions, fi is a vector of bank is factor
input prices.
The second equation is an implication of the model is that the zero profit constraint
holds at the industry level:

From this we can interpret the H statistic as responsiveness of revenue to factor

prices:

Roze and Panzar, in Structure, conduct and comparative statistics1982 have

shown how we can categorise the market based on H, and this is shown in the next
section vide Tables 3a and 3b.

3. Data and Methods

Data has been fetched from Bank Scope and consists of 11 Banks surviving in the
economy from 2007 to 2013.
We have 73 observations, because of disinvestments in the relevant period as well, so
the panel of ours is an unbalanced panel.
The Rose-Panzar Model is an obvious candidate as it suffers from less anticompetitive bias in small samples, when the economy is in transitional disequilibrium.
As a break from previous Structural Equation Models it has fewer restrictions, and is
therefore robust to small sample bias, and helps analysing changing conditions and
policy to precision. To accommodate heterogeneity across the banks, an errorcomponent model, with Bank- and time-specific fixed effects is used. Finally,
following Competitive conditions among the major British banks2007, it can
be argued that the economy is recovering, so Growth in GDP is covered as a
component as well. In the following equation, REV stands for ratio of bank (interest)
revenue to total assets; PL denotes personnel expenses to employees (unit price of
labour); PK denotes other expenses to xed assets (proxy for unit price of capital); PF
denotes ratio of annual interest expenses to total loanable funds (unit price of funds),
RISKASS denotes the ratio of provisions to total assets, and ROA is the Return on
assets.

--------- (1)
Subscript i denotes ith Bank and t denotes year, in accordance with standard Panel
symbols. denotes the unobservable bank-specific fixed effect and denotes IID
random error, tested on Gaussian assumptions. It is not required to break the timesample for test of distinct trends, or for structural breaks, as done in Competitive
conditions among the major British banks2007 which underlie methods in
addressing the problem of simultaneity between real GDP and Growth term, mainly
because the conditions of post recovery is quite rigid, and real GDP (not nominal gdp)
would be hardly affected in this case.
The statistic of interest is the H statistic:

Table 3a. Interpreting the Panzar-Rose H-statistic

Parameter Region

H 0

0 H 1

Competitive Environment Test

- Monopoly or conjectural variations short-term oligopoly.
- Each bank operates independently as under monopoly
profit maximizing conditions.
- H is a decreasing function of the perceived demand
elasticity.
- Monopolistic competition
- Free entry (Chamberlinian) equilibrium excess capacity.
- H is an increasing function of the perceived demand
elasticity.

H 1

- Perfect competition, or natural monopoly in a perfect

contestable market, or sales maximizing firm subject to
break even constraint.
- Free entry equilibrium with full (efficient) capacity
utilization.

The equilibrium condition is modelled as:

Where denotes the bank specific individual effect. Again equilibrium H is:
----------(2)

Table 3b. Interpreting the Panzar-Rose H-statistic (contd.)

Parameter Region Market Equilibrium Test
H=0

- Equilibrium

H 0 (truncated)

- Disequilibrium

It is summative that if the sample is not in the long-run equilibrium, H<0 in the first
regression no longer establishes monopolistic market conditions, but remains true that
H>0 disproves monopoly or conjectural variation short-run oligopoly.

4. RESULTS
Equation for Competitive Equilibrium (Results of regression eqn. 1)
Dependent Variable: @LOG(REV)
Method: Panel Least Squares
Date: 01/02/15 Time: 22:08
Sample: 2007 2013
Periods included: 7
Cross-sections included: 11
Total panel (unbalanced) observations: 65
Variable

Coefficient Std. Error

C
3.732273
@LOG(PK)
0.201472
@LOG(PF)
-0.176428
@LOG(PL)
0.008421
@LOG(RISKASS)
0.096573
@LOG(TOTAL_ASSETS
)
-0.475124
GROWTH
0.021890

t-Statistic

Prob.

3.122028
0.098942
0.064196
0.116216
0.063172

1.195464
2.036251
-2.748276
0.072462
1.528736

0.2378
0.0473
0.0084
0.9425
0.1329

0.158060
0.017672

-3.005982
1.238688

0.0042
0.2215

Effects Specification
Cross-section fixed (dummy variables)
R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
F-statistic
Prob(F-statistic)

0.806541
0.742055
0.253028
3.073101
6.949255
12.50720
0.000000

Mean dependent var

S.D. dependent var
Akaike info criterion
Schwarz criterion
Hannan-Quinn criter.
Durbin-Watson stat

-4.820703
0.498201
0.309254
0.877940
0.533637
1.547120

Wald Test:
Equation: Untitled
Test Statistic

Value

df

Probability

t-statistic
F-statistic
Chi-square

2.780360
7.730403
7.730403

48
(1, 48)
1

0.0077
0.0077
0.0054

Normalized Restriction (= 0)

Value

Std. Err.

C(1) + C(2) + C(3) + C(4)

3.765738

1.354406

Null Hypothesis: C(1)+C(2)+C(3)+C(4)=0

Null Hypothesis Summary:

Restrictions are linear in coefficients.

We can do a one tailed truncated F- test, manually as Eviews does not do a one tailed
test.
P(H>0)= 0.007733
We reject the Hypothesis that H>0 (and therefore H>1) finding strong evidence
in favour of Monopoly.
9

Series: Standardized Residuals

Sample 2007 2013
Observations 65

8
7
6
5
4
3

Mean
Median
Maximum
Minimum
Std. Dev.
Skewness
Kurtosis

-1.71e-18
-0.021305
0.568280
-0.568280
0.219128
0.239797
3.328333

Jarque-Bera
Probability

0.914910
0.632892

2
1
0
-0.6

-0.4

-0.2

0.0

0.2

0.4

0.6

We are unable to reject normality (by Jacque Bera Probability), which means we are
correct in our estimates. Adding a lagged growth term reduces the adjusted R squared,
and the residual fitted plot below does not show any distinct trend in error terms or
trend in volatility.
3

-1

-2

Barclays Bank Plc - 07

Barclays Bank Plc - 09
Barclays Bank Plc - 11
Barclays Bank Plc - 13
Britannia Building Society - 09
HBOS Plc - 09
HBOS Plc - 11
HBOS Plc - 13
HSBC Bank plc - 08
HSBC Bank plc - 10
HSBC Bank plc - 12
Lloyds Banking Group Plc - 07
Lloyds Banking Group Plc - 09
Lloyds Banking Group Plc - 11
Lloyds Banking Group Plc - 13
Paragon Group of Companies Plc - 08
Paragon Group of Companies Plc - 10
Paragon Group of Companies Plc - 12
Royal Bank of Scotland Group Plc (The) - 07
Royal Bank of Scotland Group Plc (The) - 09
Royal Bank of Scotland Group Plc (The) - 11
Royal Bank of Scotland Group Plc (The) - 13
Schroders Plc - 09
Schroders Plc - 13
Skipton Building Society - 10
Skipton Building Society - 12
West Bromwich Building Society - 08
West Bromwich Building Society - 10
West Bromwich Building Society - 12
Yorkshire Building Society - 07
Yorkshire Building Society - 09
Yorkshire Building Society - 11
Yorkshire Building Society - 13

-3

Standardized Residuals

While our model seems correctly specified tests for the H statistic is inconclusive, we
fail to reject the direction of H both ways.

Equation for Equilibrium (Results of regression eqn. 2)

Since Banks did incur negative returns on assets, we have, following What Drives
Bank Competition? Some International Evidence2004, modified ROA to 1+ROA
to suit our equation. Since we are taking logarithms we cannot have negative values.
Dependent Variable: LOG(ROA)
Method: Panel Least Squares
Date: 01/02/15 Time: 23:43
Sample: 2007 2013
Periods included: 7
Cross-sections included: 11
Total panel (unbalanced) observations: 66
White cross-section standard errors & covariance (d.f. corrected)
WARNING: estimated coefficient covariance matrix is of reduced rank
Variable

Coefficient

Std. Error

t-Statistic

Prob.

@Log(C)
@Log(PF)
@log(PL)
@log(PK)

1.012886
-1.001433
-4.64E-06
-0.000305

0.000872
0.046774
1.41E-06
0.000127

1161.358
-21.40988
-3.282890
-2.405223

0.0000
0.0000
0.0019
0.0200

RISKASS
TOTAL_ASSETS
GROWTH

-0.045588
-4.92E-12
0.000181

0.146057
7.96E-13
0.000135

-0.312128
-6.185780
1.342578

0.7563
0.0000
0.1856

Effects Specification
Cross-section fixed (dummy variables)
R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
F-statistic
Prob(F-statistic)

0.980416
0.974021
0.002239
0.000246
318.8923
153.3130
0.000000

Mean dependent var

S.D. dependent var
Akaike info criterion
Schwarz criterion
Hannan-Quinn criter.
Durbin-Watson stat

0.990996
0.013891
-9.148250
-8.584248
-8.925386
1.535601

Wald Test:
Equation: Untitled
Test Statistic

Value

df

t-statistic

0.240987

49

F-statistic
Chi-square

0.058075
0.058075

(1, 49)
1

Probability

0.966307
0.966307
0.9596

Null Hypothesis: C(1)+C(2)+C(3)+C(4)=0

Null Hypothesis Summary:
Normalized Restriction (= 0)
C(1) + C(2) + C(3) + C(4)

Value

Std. Err.

0.011144

0.046242

Restrictions are linear in coefficients.

H0: H=0
HA: H<=0
Since F-statistic =0.966307
> .05, we fail to reject the null hypothesis, that H=0
In fact we can see at .05 and more significance levels, we can reject that H<=0

5. Conclusion and Further Ideas

Our findings in the Post-Crisis era concur with those in the pre-crisis era. We have
both stable equilibrium and strong monopoly tendencies, monopolistic or short run
oligopolistic pricing, concurring with the high observed HHI. A full-fledged study
should however, compare the pre and post crisis data using chow tests, and rolling
window methods. We also left out Non-Interest Operations of Banks. However, these
can be oligopolistic as well. A model cannot be completely justified unless potential
rival models are out ruled using GMM and similar methods. Finally the policy
extension. We all know Banking is monopolist. How this happens needs to be studied
into. Ideally Growth is a proxy for what we call a signal, which perhaps coordinates
this cartel like behaviour. Clearly implicit Hedging and other Bailout policies need to
be regulated, auditing firms concerns need to be looked into. Dwelving into all this,
8

however goes beyond the current scope (and word limits).

Appendix A

Disclaimer:
1. Eviews 8.1 has been used. The author is not affiliated to Eviews, nor is it asserted
that he is doing the best use of the same, nor is he endorsing/ reccomending its use.
Eviews is a registered trademark of IHS Global Inc., 15 Inverness Way East,
Englewood, CO 80112, USA.
2. In the following code, Proxies and Data imputation has been toyed into. In real
world an array of data resources like Bloomberg could be used to intraplate this kind
of data using Classification methods. Although the bite is not strong, user discretion is
advised.

Code for Computing the HerfindahlHirschman Indices:

table(8,2) hhi
hhi(1,1)="Year"
hhi (1,2) = "HerfindahlHirschman Indices"
for !i = 1 to 7
!Y = @sum(net_interest_income)
genr sharehhi=((net_interest_income/!Y)*100)^2
smpl @first+!i-1 @first+!i-1
hhi(!i+1,1) = year(1+!i-1)
hhi(!i+1,2) = @sum(sharehhi)
next

Code for computing Competitive Equilibrium

genr
numemployee=@nan(number_of_employees,@nan(@nan(number_of_employees(1),number_of_employees(+3)),number_of_employees(+1)))
numemployee(1)=13490
genr pl = personnel_expenses/numemployee
genr REV = net_interest_income/total_assets
genr PK= OTHER_OPERATING_EXPENSES /FIXED_ASSETS
genr PF = TOTAL_INTEREST_EXPENSE /(TOTAL_ASSETS -FIXED_ASSETS LOAN_LOSS_PROVISIONS )
genr RISKASS = LOAN_LOSS_PROVISIONS /TOTAL_ASSETS
LS(CX=F) @LOG(Rev) @LOG(PF) @LOG(PL) @LOG(PK) @LOG( RISKASS
)@LOG(TOTAL_ASSETS) GROWTH
LS(CX=F) @LOG(ROA) @LOG(PF) @LOG(PL) @LOG(PK) @LOG( RISKASS
)@LOG(TOTAL_ASSETS) GROWTH

Bibliography
Competitive conditions among the major British banks MatthewsKent,
MurindeVictor, ZhaoTianshu2007Journal of Banking & FinanceVol. 31
pp.20252042

Conduct in a banking duopoly Sherrill Shaffer; James Disalvos.l.Journal of

Banking & Finance1994
Financial Dependence, Banking Sector Competition,and Economic Growth Stijn
ClaessensLucLaevens.l.World Bank Policy Research Working Paper 34812005

How (Not) to Run Auctions:the European 3G Telecom Auctions

KlempererPaul2002European Economic Review,
How do UK financial institutions really price their products? Journal of Banking &
Finance HeffernanS.A.,2001Vol. 26
Structure, conduct and comparative statistics Panzar, J., Rosse, J.Paper No. 248.
s.l.Bell Laboratories Economic Discussion1982
What Drives Bank Competition? Some International Evidence ClaessensStijn,
LaevenLucs.l. Journal of Money, Credit and Banking, Blackwell Inc2004

10