Working Paper 168 - Competition and Market Structure in the Zambian Banking Sector

Studies on banking competition in developing countries, and especially in Africa, are sparse. This study evaluates the degree of competition in the Zambian banking sector in the wake of dynamic market shifts induced by entry of new foreign banks and privatisation of the state-owned bank. Using a detailed bank-level panel data set, we measure competition using the H-statistic and the time varying Lerner index. The estimation of Lerner index provides the first ever documented empirical evidence on the evolution of competition in the Zambian industry. This is important in assessing foreign influence on competitiveness. For the H-statistic, results show that Zambian banks earned their revenue under conditions of monopolistic competition. This finding is corroborated by the estimate of the Lerner index which suggests that the degree of competitiveness may not be as low as previously understood. The study shows that risk taking, revenue diversity and regulatory intensity are all important determinants of market power. Tight monetary policy is also found to strengthen the banks’ exercise of market power. Generally, the findings lend support to previous research suggesting that increased foreign bank penetration and divestiture of state ownership in banking can heighten competitive pressures in the banking sector. Thus, the main policy lessons drawn from the analysis is that competitive conditions could be further enhanced by easing regulatory impediments and in the long-run, allowing more foreign bank participation could spur competitive conduct in the industry.