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The Journal of Finance and Data Science 2 (2016) 244e253
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Assessing nature of competition in banking sector of Pakistan

Muhammad Tahir, Syed Sadaqat Ali Shah, Muhammad Asim Afridi*
Department of Management Sciences, COMSATS Institute of Information Technology, Abbottabad, Pakistan

Received 2 December 2016; revised 6 March 2017; accepted 10 April 2017

Available online 13 April 2017

Abstract

This study examines the nature of competition in banking sector of Pakistan and assesses whether the banking sector is in long-
run equilibrium or not. The study uses annual panel data for a sample of 30 banks, over the period 2007e2015 by employing Rosse
and Panzar (1977) methodology. The findings show that banking sector of Pakistan is operating under characteristics of monop-
olistic competition. The findings further show that the equilibrium hypothesis is rejected for the banking sector over the period of
analysis. The current study is expected to benefit policymakers, banking sector itself and the country's central bank. The findings
confirm that massive deregulations and financial liberalization has contributed positively and has improved competitive condition
of the banking sector that is expected to improve further in the future.
© 2016 China Science Publishing & Media Ltd. Production and hosting by Elsevier on behalf of KeAi Communications Co. Ltd.
This is an open access article under the CC BY-NC-ND license (http://creativecommons.org/licenses/by-nc-nd/4.0/).

Keywords: Competition; Banking sector; Pakistan; Deregulation; Panel data; RosseePanzar model

1. Introduction

The banking sector of Pakistan is in a continuous state of evolution since deregulation initiatives launched in late
1990s. The amendments in banking act 1974 transferred shares of five big state owned banks to private sector. The
amendments had two impacts on banking sector. First, shares of state owned banks were transferred to private banks
and secondly it led to establishment of new banks in the country, consequently transforming the banking industry from
a more concentrated to less concentrated banking sector. The opening of new banks, however, created problems which
led to mergers and acquisitions. For instance small banks were unable to compete with large banks and further the
small banks were unable to maintain minimum capital adequacy requirement imposed by the central bank.
This study studies the nature of competition in banking sector after major developments in terms of establishment
of domestic banks and permitting foreign banks to operate in the country at the same cost function as established firms.
The subsequent mergers and acquisitionsa among banks call for to study what was nature of competition and to

* Corresponding author.
E-mail addresses: tahirm@ciit.net.pk (M. Tahir), syedsadaqatshah123@gmail.com (S.S.A. Shah), asimafridi@ciit.net.pk (M.A. Afridi).
Peer review under responsibility of China Science Publishing & Media Ltd.
a
For example M&A of HSBC with and into MeezanBank in 2014 and M&A of Barclay Bank with and into Habib Bank Limited in 2015
(Source: Competition Commission of Pakistan).

http://dx.doi.org/10.1016/j.jfds.2017.04.001
2405-9188/© 2016 China Science Publishing & Media Ltd. Production and hosting by Elsevier on behalf of KeAi Communications Co. Ltd. This
is an open access article under the CC BY-NC-ND license (http://creativecommons.org/licenses/by-nc-nd/4.0/).
 M. Tahir et al. / The Journal of Finance and Data Science 2 (2016) 244e253 245

investigate whether the banking market was in long-run equilibrium or not. This study therefore, first, assesses nature
of competition in country's banking sector and secondly investigates whether the banking market was in long-run
equilibrium or not.
The studies of Mahmood1 and Mirza et al.2 have investigated banking sector of Pakistan in terms of concentration
and market power exercised by banks respectively. The previous studies have multiple flaws when measuring degree
of competition in the banking market. For example the study of Mahmood1 excluded the impact of minimum capital
requirement (MCR), minimum capital adequacy ratio (CAR) and minimum deposit rates on competition in the
banking industry because the requirement by the central bank changed dynamics of competition in the banking
sector.b Similarly their studies fall short in considering overall banking market. In other words the studies neglected to
consider overall banking sector instead of taking selected banks (for instance our study takes into account all banks
operating across the country- Islamic banks, specialized banks, public and private banks and foreign banks respec-
tively). In addition the econometric model employed by Mirza et al.2 has ignored to include macroeconomic variable
although the macroeconomic (annual GDP growth) variable also impact banking sector in an economy and that GDP
and competition in banking industry are interrelated. Further as Mirza et al.2 has researched banking sector from 2004
to 2012 it means his study has not taken into account Islamic banks in their study.
This study overcomes all these discrepancies by, first, considering overall banking sector, regardless of their
specialist practices. Second the current paper, unlike previous study2 which has used quarterly data to measure
competitive level, consider annual reports instead of quarterly or half year reports published by the banks to measure
nature of competition. Thirdly, due to imposition of MCR and CAR by the State Bank Pakistan, country's banking
sector regulator, the study intends to investigate whether or not the banking sector is in long run equilibrium, and
finally the study considers a time series macroeconomic variable (annual GDP growth) to see its impact on banking
competition.
The rest of the paper is patterned as follow. Section 2 of the paper presents historical background and de-
velopments in the banking sector of Pakistan. Section 3 briefly reviews relevant literature. Section 4 details theory,
methodology and data sources. Section 5 explains empirical results and discussion. Section 6 concludes and gives
future directions.

2. Developments in banking sector of Pakistan

Prior to initiation of reforms in banking sector of Pakistan in the end of 1990 the banking industry of the country
was dominated by five big banks.c Amendments were made in 1991 in Banking Act of Pakistan 1974 to align banking
sector of the country with international standard, improve efficiency, competitiveness of the sector to its advantage and
to attract private sector investment. The amendments in the act resulted in a more liberalized banking industry. The
deregulations of state owned banks resulted in large private sector investment in the sector which attracted new
competitors through licenses issued to them by State Bank of Pakistan. This move of issuing licenses to new entrants
consequently increased shares of the private sector, subsequently lowering overall concentration of the banking
market.
The privatization opened the economy for new domestic and foreign entrants, increased the scope and importance
of information technology, pushed banks to adopt efficient ways to grab market shares and exercise their market
power. The excessive use of information technology and employment of skilled human resource now differentiate
banks from their market competitors. The banking sector has displayed remarkable and notable performance not only
in monetary terms but has promoted a culture of professionalism, innovation, efficiency and inclusion of unbanked
population in the financial system through offering branchless banking. The competition has since then intensified and
the customers are now feeling comfortable with services of banks.
The banking sector, however, experienced shrinkage and a tilt toward concentration when the newly established
small banks were unable and incapable to compete with large banksd which ultimately led to mergers and acquisitions

b
The imposition of minimum capital requirement (MCR) and minimum capital adequacy ratio (CAR) by SBP in 2008 forced smaller banks to
merge with larger banks thereby changing the environment of competition.
c
National Bank of Pakistan, Allied Bank of Pakistan Limited, Habib Bank Limited, Muslim Commercial Bank, United Bank Limited.
d
According to ESH hypothesis large banks, in terms of profitability, performs well as compared to small banks for reasons they are more
efficient than small banks.
246 M. Tahir et al. / The Journal of Finance and Data Science 2 (2016) 244e253

in the sector. The mergers and acquisitions forced State Bank of Pakistan in 1995 to impose moratorium on issuing
commercial banking licenses to new banks. One reason of subsequent mergers and acquisitions in the banking sector
was requirement of minimum capital requirement laid by State Bank of Pakistan (SBP). Second reason for mergers
and acquisition in the banking sector was establishment of Islamic banks because the new mode of banking attracted
massive deposits in the years after its establishment. Therefore to prevent banks from liquidity problems and sub-
sequent expected bankruptcies the SBP as per prudential regulations required banks to raise their minimum capital
adequacy requirement from Rs 5 billion in 2008 to Rs 23 billion by the year 2013. Developments in banking sector
recently and establishment of Islamic banks therefore call for to study overall banking sector instead of selected banks.
The country's banking sector although has been recognized for its rapid growth, efficiency, promotion of profes-
sionalism and low cost products and services, the sector has been on the other hand engulfed by dilemma of high
interest spread,e one reason behind higher profitability of banks.
Although the banking sector during decades of its operations after deregulation has shown remarkable performance
it has not been researched whether the market has been competitive and contestable, that is no research to date has
been done to assess nature of competition in banking sector of the country and to test whether the sector is in long run
equilibrium. This paper is expected to benefit banking sector itself, the central bank and policy makers in the future.
This paper in addition will help policy makers whether to bring changes in regulatory environment so as to ensure
competition in banking sector, subsequently to achieve financial stability.

3. Literature review

Various approaches have been employed to measure and quantify competitiveness of banking sector.3e7 These
methodologies, specifically Rosse and Panzar5 and Panzar and Rosse,8 have also been extend to industries other than
banking (see Refs. 9,10,11), however with criticism on the H-statistic (see Refs. 12e15).
A number of studies conducted in different countries by employing different methodologies indicate banking
markets operate under monopolistic competition (see for example, Refs. 16e23). The study of Bikker and Haaf24
finds that banks in EU are characterized by monopolistic competition and that the competition in local markets is
weakerf and stronger in international markets. Testing for an impact of consolidation on competition in banking sector
of Korea revealed that the sector has not been impacted.25 De Bandt and Davis26 on the other hand find that in
Germany the banks operated under monopolistic competition and in case of France the small banks exercised mo-
nopoly. The investigation of Arab Middle Eastern banking sector27 and the banking industry of eight countries in Latin
America and Europe28 by employing P-R methodology indicate the banking industry operate under monopolistic
competition.
The results of Lerner29 and Lerner and Boone30 indicate declining banking competition during 2000s for many
world economies, however the market power has increased in the post financial crisis years. However on employing
Bresnahan-Lau model Nakane31 concluded that Brazilian banking sector operate under competitive condition that is
expected to remain in long run. Simultaneously Maudos and Nagore32 employ Lerner Index and find a U-shaped
relationship between size of the banks and the market power. They indicate a positive link between concentration and
market power and that efficient banks exercise market power. In case of Argentina Burdisso et al.33 report presence of
almost perfect competition for the period 1997e1999. Williams34 investigated Latin American banking sector for
estimation of market power and indicates that competitive condition fell over the period 1985 to 1990 although the
market operated under monopolistic competition.
Although competition in banking sector is beneficial in terms of efficiency, it however induces financial insta-
bility.35 This argument is supported by study of Boyd and De Nicolo36 that financial stability is affected by stronger
market power exercised by banks which subsequently leads to bankruptcy. The research of Berg and Kim37 studied the
impact of multi-product operations on competition in banking sector. They examine banks' behavior in a segment
where retail as well as corporate banks operate simultaneously. Asymmetries in level of competition were revealed by
the study which in each segment can be compared to consumers' characteristics. Similarly Abel and Le Roux38
investigated Zimbabwean banking sector by employing widely used PanzareRosse H-statistic to measure

e
SBP has now laid minimum rate on PLS accounts with effects from June 1, 2008. Source: mahmood.khan@sbp.org.com.
f
Caminal and Matutes50 argue that when banking sector is not competitive credit rationing shrinks, loans are larger subsequently enhancing
chance of banking sector failures.
 M. Tahir et al. / The Journal of Finance and Data Science 2 (2016) 244e253 247

competition in the country's banking sector for the period 2009e2010. The findings of the study indicate the banking
sector of Zimbabwe operated under characteristic of monopolistic competition with H-statistic ranging between 0.46
and 0.56. In other words the H-statistic is neither negative, indicating monopoly situation, nor greater than a unit,
indicating existence of perfect competition.
In contrast to measuring competition in the banking sector the study of Barbosa et al39 investigated Brazilian
banking sector by taking into account multi-product banking operations. The study, in other words, investigated
whether or not multi-products offered by banks have impact on market power. The findings show that banks exercise
market power if and when they offer classic banking products (loans and credit cards) as well as other banking
products (brokerage services, insurance as well as capitalization bonds) in contrast to banks that offer only classic
banking products.
On investigating banking sector of Morocco, by considering five banks holding about 80 percent of market's credit
shares, the finding of Fatine et al.40 show that the banking sector is not competitive by price/quantity and is char-
acterized by monopolistic competition. Similarly the findings, by employing PanzareRosse model, indicates that
between 1993 and 2010 the banking sector claim stabilization in competitive level, varying from 0.37 to 0.28,
however, indicating decline in degree of competition.
Exploring banking sector of Fiji for competition by employing PanzareRosse H-statistic the findings of Kumar and
Patel41 indicate that the banking sector of Fiji operate under characteristic of monopolistic competition and that the
competition in the banking sector is biased toward monopoly or short-run oligopoly. The H-statistic of 0.254 and
0.180 indicate that the banking sector of Fiji is characterized by lower level of competition. Furthermore the findings
show that revenues of the banks are positively impacted by interest expenses, CAR, number of branches and nega-
tively impacted by personnel expenses, firm size, and other operating expenses.
On investigating banking sector of India Datta42 shows that due to trend of globalization the banking sector
competition in the country has improved and the competition in the sector is expected to improve further in the
future. Employing Bresnahan-Lau model the results indicate the competition in banking sector of India is less than
monopoly and more than Cournot oligopoly. Another study by Vesala43 by examining competitiveness in Finnish
banks over a period of eight years, 1985e1992, concluded that higher level of contestability existed for the sampled
period. To find evidence of existence of competitiveness in banking sector Spiller and Favaro44 researched Uru-
guayan banking sector and suggested that the response of banks vary to actions of other banks in the same banking
sector.
The literature review shows that the research on competition in banking market around the globe is abundant;
however any research relevant to banking market in Pakistan is rare. The research of Mahmood1 and Mirza et al.2
respectively as measuring competition in country's banking sector is not sufficient to justify that the banking sector
is competitive. For example the study of Mirza et al.2 have measured degree of competition in banking sector of
Pakistan by explaining quantitatively level of competition in the banking market. Similarly the study used quarterly
dataset for assessing degree of competition in the banking sector. This study on the other hand measures nature of
competition in the banking sector of Pakistan instead of measuring degree of competition in the banking sector. This
study is different because in measuring nature of competition in the banking sector requires to test, firstly, whether or
not the banking sector is in long-run equilibrium which is not covered in the previous papers. Simultaneously this
study overcomes existing discrepancies by employing Rosse and Panzar H-statistic5 instead of Panzar and Rosse8
H-statistics to quantify competitive condition of the banking sector and to test whether or not the banking sector is
in long-run equilibrium. Secondly the study employs annual dataset to quantify nature of competition in the banking
sector of the country. Simultaneously the imposition of MCR and CAR by country's central banks has enforced banks
to merge with larger financially stronger banks to retain banking sector stability and to prevent depositors' money. The
focus on overall banking sector of the country is interesting. Firstly, because the market structure after de-regulations,
mergers and acquisitions and establishment of Islamic banks have apparently brought tremendous changes in banking
sector, It is therefore of utmost significance to assess nature of competition in the banking sector. Secondly, since
regulatory measures too have changed since de-regulation it is important to test how competition has varied after de-
regulation. Thirdly, any change in Prudential Regulations (PR hereafter) and regulatory measurements have direct and
natural impact on banking sector, therefore the study calls for investigation of the competitive condition of the banking
sector and to examine whether the market is in long-run equilibrium or not.
This paper therefore aims to extend existing literature to banking sector of Pakistan by first assessing nature of
competition in the banking sector and secondly to investigate whether the sector is in long run equilibrium by using
248 M. Tahir et al. / The Journal of Finance and Data Science 2 (2016) 244e253

annual panel data of 30 sampled banks for the period 2007e2015 by employing RosseePanzar H-statistic
methodology.

4. Theory, model specification and data

4.1. Theory

Structure Conduct Performance (SCP hereafter) model23 dominated early studies to identify structure of the
market. The assumptions of these studies were that the market structure is exogenous that is any change in structure
impact conduct of the firm and subsequently the performance of the firm. In these studies profitability was regressed on
concentration ratio in these studies and the results, subsequently, suggested a positive relationship between profit-
ability and concentration ratios. The results showed that market power is exercised by banks in concentrated markets.
Efficient Structure Hypothesis (ESH) on the other hand suggests otherwise; in terms of profitability large banks tend to
perform very well as compared to small banks because of their efficiency.23 Both SCP and ESH however do not end
debate because both of them have deficiencies. For example they both focus only on profitability instead of deviation
of output price from marginal cost e it is most suitable theoretical basis for measuring competitive condition.45
New Empirical Industrial Organization (NEIO) overcomes these discrepancies.23 Two most commonly used ap-
proaches in this strand of literature are Rosse and Panzar5 reduced-form revenue framework and BresnahaneLau3,4
respectively. The robustness of ReP is higher in small samples whilst an anticompetitive bias is shown by Bresna-
haneLau model in small sample.46

4.2. Model specification

This study uses RosseePanzar methodology to assess nature of competition in banking sector of Pakistan. Log
linear revenue, as dependent variable, is employed to assess competitive condition in banking sector while log return
on assets is used to find out whether the banking market is in long run equilibrium or not.
Multiple non-structural measures5; Panzar and Rosse, 1982,7; Lerner Index, 1934,47; Boone Indicator, 2008) have
been employed to assess competitive conditions in the banking sectors. Simultaneously when it is unfeasible to
employ structural measures to quantify competitive conditions,g the reduced form revenue approaches are employed
to measure and quantify competitive conditions in the form of differentiating conduct of the firm and the market
power. Albeit less powerful than structural measures the data requirement in reduced-form revenue models are less
stringent and thus minimizes the risk of employing model characterized by misspecification.10 The non-structural
measure known as RosseePanzar H-statistic does not necessitate the availability of required data on output and
input levels,48 it however takes into account firm-specific rental cost of capital services.
The empirical estimation is performed in two steps. In the first step the study assesses nature of competition in
banking sector of Pakistan and in the second step the study estimates whether banking market is in equilibrium or not.
For estimating competitive condition the following reduced form revenue equation is employed:
X
J X
K X
N
ln Rit ¼ a0 þ aj ln Wjit þ bk ln Xkit þ gn ln Znt þ εit ð1Þ
j¼1 k¼1 n¼1

where Rit is total revenue of the bank i in year t, Wjit is vector of input price (PL, Price of labor; PK, Price of capital; PF.
Price of fund), Xkit is a vector of bank-specific variable (RISKASS, ratios of provisions to total assets; ASSETS, total
assets; BR, number of branches of each bank to the total number of all banks), Znt is a of macroeconomic variable
(annual GDP growth) that impact overall banking market and εit is a stochastic disturbance term. The vectors i and t
denotes bank and time in years respectively. Reduced form revenue equation is employed to calculate ReP H-statistic.
In equation (1), The Rosse and Panzar H-statistic5 is calculated from reduced form revenue equation. H is the sum of
elasticities of total revenue with respect to each of the bank's input prices (that is PL, PK, PF).

g
The structural measures become unusable due to unavailability of required data for quantifying competitive conditions or when the model
adequacy or competency in measuring the competitive conditions becomes questionable.
 M. Tahir et al. / The Journal of Finance and Data Science 2 (2016) 244e253 249

X
J
H¼ aj
j¼1

The conditions for market to be monopolistic, monopoly or perfect is given in Table 1.

For testing H-statistic it is important to first test whether the banking market is in long-run equilibrium or not.
Therefore to test the market for equilibrium we replace ln Rit in eq. (1) with pre-tax profit to total assets. The equation
to test for equilibrium is as follow:
X
J X
K X
N
ln qit ¼ a00 þ a0j ln Wjit þ b0k ln Xkit þ g0n ln Znt þ mit ð2Þ
j¼1 k¼1 n¼1

For equilibrium,
X
J
E¼ a0j ¼ 0
j

The theory of competitive condition and equilibrium condition23 is explained in Table 1.

4.3. Data sources

Yearly annual reports has been collected from individual bank's website and from the website of country's central
bank, State Bank of Pakistan, spanning over nine years from 2007 to 2015. The study has considered overall banking
sector, including commercial banks, Islamic banks, specialized banks, and foreign banks. Due to unavailability of
required data the study takes into account a sample 30 banks. The data for time series macroeconomic variable annual
GDP growth has been obtained from World Development Indicators (WDI), World Bank.
The study uses panel data with fixed effects. Fixed effect model is considered more appropriate than random effect
model as evidenced by the results of Hausman.49 To deal with heterogeneity panel data is an effective and appropriate
way because; the data is more informative, there is higher variability, collinearity is low or no collinearity is present,
the degree of freedom and the efficiency is higher respectively. Hausman test is conducted to whether run fixed or
random effects. Due to rejection of H0 or in other words acceptance of H1 and significance at 5 percent it is justified to
use fixed effects. The results are shown in Table 2.

5. Results and discussions

5.1. Equilibrium in banking sector

For estimating competitive condition in the banking market it is required to test whether the market is in long run
equilibrium or not. Because the banking sector over recent years has witnessed major changes through mergers and
acquisitions non-existence of equilibrium over period of analysis is not a surprise. The results are presented in Table 3.
The result of E ¼ 0.10828 indicates that equilibrium hypothesis is rejected for the banking sector over the period
of analysis. The equilibrium test was performed to see any impact of explanatory variables on ROA. The coefficients
of PL (unit cost of labor), PK (unit cost of capital) and PF (unit cost of fund) as 0.019, 0.004 and 0.093 respectively

Table 1
Conditions for competitive banking market.
Competitive conditions
- H  1 indicates banking market has monopoly.
- H ¼ 1 indicates existence of perfect competition, natural monopoly or sales maximizing firms.
- 0 < H < 1 means market operates under characteristic of monopolistic competition.
Equilibrium conditions
- E ¼ 0 shows that market is in long-run equilibrium.
- E < 0 shows non-existence of equilibrium or market is in dis-equilibrium.
250 M. Tahir et al. / The Journal of Finance and Data Science 2 (2016) 244e253

Table 2
Hausman specification test.
Competitive condition model Equilibrium condition model
Chi-Sq stats 43.7530 38.4558
Chi-Sq d.f 7 7
Prob 0.0000 0.0000
Hausman test is conducted to choose between fixed and random effects.

Table 3
Estimates of equilibrium, dependent variable LNROA.
Variables Coefficient Standard error t-stats Prob.
C 0.1179 0.0488 2.4136 0.0166
Price of Labor 0.0189 0.0042 4.4453 0.0000
Price of Capital 0.0041 0.0014 2.9089 0.0040
Price of Fund 0.0934 0.0463 2.0131 0.0453
Ratios of provisions 1.0118 0.0345 29.2739 0.0000
to total assets
Total Assets 0.0087 0.0034 2.5652 0.0109
No. of Branches 0.0075 0.0028 2.6777 0.0079
Annual GDP Growth 0.0012 0.0007 1.7096 0.0887
R2 ¼ 0.8150
F-stats (Probability) ¼ 28.5174 (0.0000)
E ¼ 0.10828

shows that input prices PL and PF negatively impact ROA in the long run. The high cost of labor impacts banks in
terms of lowering their returns in long run. Similarly banks that have high cost funds in terms on interest payment can
cost banks in terms of returns. The positive impact of PK on ROA indicate that if efficient capital is employed then
even if cost of capital is higher the banks still can enjoy positive returns on assets in the long run. In other words banks
that spend more on capital (in other words banks spending more on intellectual capital in the form of periodic training
and development of employees) enjoy positive returns on assets. The results show that PL, PK, RISKASS and BR are
statistically significant at one percent significance level, PF and ASSETS are significant at 5 percent level whilst GDP
is significant at ten percent significance level. The estimated equation has good explanatory power because the
explanatory variables show 81.5 percent variation in dependent variable.
The negative impact of RISKASS on ROA shows that provisions against non-performing loans in the long run
affect banking return on assets negatively. This poses two threats to the banks in the long run. Firstly, higher the
provisions against non-performing loans the lower the money available for banks in the future to lend to investors.
Secondly additional cost is incurred by banks when loans are waived off or when borrower defaults on loans.
Furthermore the positive relation of ASSET shows that the more the assets banks have higher will be return on assets.
However keeping unnecessary branches can have negative impact on banks' ROA. Although the results show an
opposite relationship between GDP and ROA the impact however is negligible. The relationship between GDP growth
and ROA suggest they both are related to each other as any change in equilibrium will have change in growth of GDP
and vice and versa.

5.2. Competition in banking sector

By obtaining estimates of equilibrium model we can without any hindrances calculate H-statistic for competitive
condition. Our finding of H-statistic of 0.728 is closer to the finding of Mahmood1 whose findings are in range of
0.8e0.9 but far from finding of Mirza et al.2 whose results suggest H-statistic of 0.99.h The results of competitive
condition are presented in Table 4.

h
The wider deviation between the current study and study conducted by Mirza et al.2 could be due to inclusion of overall banking sector or could
be due to employment of annual data, rather than quarterly data, for the analysis purpose.
 M. Tahir et al. / The Journal of Finance and Data Science 2 (2016) 244e253 251

Table 4
Estimates of competitive condition with dependent variable LNREV.
Variables Coefficient Standard error t-stats Prob.
C 3.871 2.1859 1.771 0.078
Price of Labor 0.331 0.1003 3.305 0.001
Price of Capital 0.066 0.0240 2.735 0.007
Price of Fund 0.331 0.2840 1.166 0.245
Ratios of provisions to 0.821 1.8627 0.441 0.660
total assets
Total Assets 0.380 0.1474 2.580 0.010
No. of Branches 0.370 0.1171 3.163 0.002
Annual GDP Growth 0.024 0.0176 1.384 0.168
R2 ¼ 0.5890
F-stats (Probability) ¼ 9.2786 (0.0000)
H ¼ 0.728717

The results indicate that except PF, RISKASS and GDP the ratios of PL, PK, ASSET and BR are statistically
significant at one percent significance level. The coefficients of input prices show a positive impact on revenue of
the banks. The value of H-statistic of 0.728 shows that banking sector of Pakistan operates under characteristic of
monopolistic competition. Cost of labor increases when banks open new branches to meet the market demand and
to maintain market shares. Opening up of new branches increases every sort of cost for the bank at a rate that
revenue at all times exceeds expenses. The value of cost of capital is interesting because it is positively related to
bank revenue. Due to induction of professional and qualified staff by banking industry the cost of capital too has
risen for banks, however, the relationship is negligible and the impact is minimum. The negative value of ASSET
indicates that it may cost banks in terms of profitability if they hold unnecessary or excessive assets at hand, thereby
impacting future investment and overall economy.i Simultaneously the negative RISKASS shows that revenue of the
bank erodes when banks increase provisions against loans. The existence of opposite relationship between REV and
GDP is interesting. Any change in competitive environment impact country's GDP growth. The relationship here,
however, is negligible.

6. Conclusion and future directions

The study intended to assess competition in banking sector of Pakistan over the period 2007e2015 by employing
yearly data obtained from websites of respective banks and country's central bank. The study employed methodology
of RosseePanzar for the sample banks to carryout analysis. The results are consistent with results of Matthews et al.23
which show that British banking operated under monopolistic competition when Rosse and Panzar5 methodology is
employed. The results show that banking sector of Pakistan is monopolistically competitive and that the banking
market of the country is not in long-run equilibrium which means that major ins and outs are happening in the country's
banking market through mergers and acquisitions. The merging of banks and acquisitions by banks show that the
dynamics of competition are changing in the banking market subsequently improving overall competition in the
banking market.
Although competition over years has improved considerably in the banking market it is important to strengthen the
banking sector further by further improving regulatory environment by minimizing barriers to banks to enter the
market. Banking sector of the country should be further investigated. For example:

 A multi-product approach should be used to assess competitive condition because banks in the country over the
recent past decade are offering more products to their customers than before which therefore calls for inves-
tigation in whether the banking sector is competitive or not.
 The behavior of commercial banks (conventional versus Islamic bank) should be investigated to find nature of
competition and to test whether the market is in long run equilibrium for reason that the shares of Islamic banks

i
Banks that keep higher assets at hand are expected to impact banking sector and overall economic growth because when they hold higher
unnecessary assets at hand they spent less on investment which subsequently costs overall economy.
252 M. Tahir et al. / The Journal of Finance and Data Science 2 (2016) 244e253

in the banking sector since its inception has multiplied, so the competition should be quantitatively measured
and assess which banking model is more competitive. This sort of investigation will show which mode of
banking is prioritized by customers and depositors.
 Due to recent mergers and acquisition against backdrop of requirement of minimum paid up capital and min-
imum deposit rates by country's central bank in the banking sector it should be tested whether the mergers and
acquisitions in the banking industry has resulted in concentrated banking sector and to find its subsequent
impacts on banking competition and overall economic stability of the country.

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