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Britain’s Retail Banking Oligopoly

A recent article in the Economist describes how a newly revived bank – TSB – is hoping to dampen the detrimental oligopolistic effects the British banking industry experiences.  Analysis of the banking industry in 2000 pointed to market inefficiency as a result of prices and profits that were above perfect competition levels.  Increased concentration levels further underscore industry inefficiency: in 2008 the four largest firms controlled 65% of the market, which quickly increased to 75%.  According to a report by the Parliamentary Committee on Treasury, increased concentration has been largely driven by “a significant increase in mergers as well as the exit from the UK market.”  While high market concentration does not necessarily lead to oligopoly price levels, it is easier for firms to collude there are fewer players in the market.

In order for TBS to have an impact on the oligopolistic market, the bank needs to focus on economies of scale.  Bank branches will need to be sufficient in number to reach a sizable portion of the market.  The main costs associated with branch proliferation will be a competent workforce and adequate computer infrastructure.  The latter cost is temporarily diminished by TSB’s decision to utilize Lloyds Banking Group’s computer infrastructure, but will have to be addressed in the future.

TSB will operate within the retail banking market, defined as: “banks which predominantly accept deposits and use these funds (together with funding from the wholesale market) to make loans as well as offering other financial products to consumers and firms.”  In order to assess a firm’s profit, loan frequency and interest rates need to be examined – services such as saving and checking accounts are costs rather than sources of revenue.

The Cournot Oligopoly model is more adept at describing the retail banking industry than the Bertrand Model.  The Bertrand model focuses on price-setting and depends on firms’ abilities to adjust output and capacity – which is hard to apply in this situation.  If TBS bank offered significantly lower prices on loans, it would not immediately be able to absorb the influx in demand.  A bank’s finite workforce prevents it from taking all of the market’s customers.  Further, if the Bertrand model were applicable to the retail banking market, price and quantity would be closer to perfect competition levels.  The Cournot model – based on firms setting quantity – results in prices closer to monopoly levels and displays inefficiencies similar to the current retail banking market.  While TSB’s entrance into the market will not induce a price war toward competitive market equilibrium levels, lower price equilibrium will occur.

One Comment

  1. This is an interesting application of the ability to adjust quantity suggesting that Bertrand competition is not central.

    Now assume that the Big Four are acting in a tacit monopoly. What then is the bes strategy for TBS? Isn’t it to “buy” market share by pricing a bit below incumbents? What then would (should) incumbents do in response?

    We’ll develop at least one explicit model of that later this term.

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