Competition and Regulation in the Banking Systems of Central America and Mexico: A Comparative Study

Competition in the financial sector, especially in the banking sphere, has been a very polemic topic. The adverse selection and moral risk that characterize this sector explain the high regulation of its economic activities. This feature is geared towards solving the important information problems faced by the economic actors, so as to protect savers’ interests and ensure the stability of the financial sector as a whole. This objective, nevertheless, contradicts to some extent the aims of competition policy. On the one hand, excessive competition may create difficulties for the bank supervisor: it is easier to control a few large banks than having to do so with a large number of small ones. On the other hand, an excessive competitive dynamic may force banks to transfer a large part of their surplus to the consumer, limiting the banks’ capitalization capacity and may lead some of them to undertake excessive risks to face competition. This explains to a certain extent the existence of some regulatory arrangements – such as the requirement of relatively high minimum capital – that promote bank concentration. But, at the same time, the absence of competition can weaken market discipline and allow for inefficient practices, while the excessive concentration can reduce the supervisor’s relative power as he faces banks that are “too big to fail”. However, the recent evolution of financial markets tends to solve this contradiction. The development of banking technology has created, more than any other economic sector, a competitive worldwide space, so that local banks are facing, more than ever, a strong competition. This cannot be avoided by measures that promote local bank concentration; on the contrary, concentration can worsen some of the negative effects of excessive competition on banks’ behaviour, particularly in the negligent handling of risk. Competition promotion in local markets, together with measures that improve the local bank competitiveness so as to close the gap with the international one, is the best complement to the prudential norms. These should be revised so as to remove aspects that promote concentration and lack of competition in this sector.