17/2/2012: Harmful Competition? Not so fast...

In recent years there has been much said about the dangers of competition in the banking sector across the EU and specifically in Ireland. Unfortunately, for the proponents of the argument that less competition will be a good thing, the facts are simply not stacking up in their favor.

Since 1997 ECB has published what is known as Herfindahl Index for European banking systems. The index is a measure of the size of banks in relation to overall sector, thus indicating the actual amount of competition in the national banking system. At 1.0 Index reading, the national banking system is fully monopolized by a single firm. Closer to zero, the system is characterized by the smaller, more directly competing banks.

So here are two charts:

Both show that

1. Higher Herfindahl Index reading (lower degree of competition) does not coincide with more stable or less crisis-impacted banking systems
2. During the period of bubble formation there was a reduction, not an increase in banking sector competition in Euro Area, so greater competition did not cause or contribute to the bubble inflation. In fact, the evidence is rather suggestive of the opposite effect.
3. In Ireland, competition pressures in the banking sector actually declined significantly in the years preceding the crisis (2001-2007) and it had subsequently dropped even more dramatically during the crisis.
4. Ireland's banking sector, at any time in the data period covered, was characterized by the levels of competition comparable to those found in Austria, Spain, and France, well below those of Germany, Italy, Luxembourg and the UK and relatively comparable to those in Sweden

So no, 'harmful competition' in Irish banking sector did not cause our crisis, nor did it even contribute to it.