Dynamics of market power and stability in GCC banking: econometric analysis and policy implications

Abstract

This study provides a thorough analysis of the market power within the banking sector of the Gulf Cooperation Council (GCC) countries over the period from 2000 to 2023, by employing robust econometric models and indices. Utilizing a translog cost function model, the study estimates marginal costs and calculates initially the Lerner Index, thereby revealing substantial market power among the GCC banks. To address the issues of high collinearity and heteroscedasticity, the model is refined by highlighting the significant roles of the total assets and labor costs in determining the overall costs. Further, the Adjusted Lerner Index and the Boone Indicator confirm the prevalence of market power in the region’s banking sector. The Panzar-Rosse H-statistic analysis suggests that the GCC banking sector operates under an oligopolistic framework, where the competitive pressures are insufficient to diminish the substantial market power held by the GCC banks. Dynamic GMM panel data models also confirm the persistence of market power, showing that past market power strongly predicts the current levels with minimal fluctuations over time. The study also investigates the relationship between market power and bank stability, revealing that while higher market power is generally associated with lower bank risk, excessive market power may paradoxically increase risk, indicating a non-linear relationship. These findings highlight the importance of regulatory reforms aimed at enhancing competition and fostering a more resilient banking sector. By providing a comprehensive understanding of market power dynamics, this study offers valuable insights for policymakers and financial regulators in the GCC, thus, guiding the efforts to improve competition, reduce systemic risk, and strengthen financial stability.