Market Structure and Business Development Strategy of the Banking Sector

©2005 Monetary Authority of Macao













Market Structure and Business Development
Strategy of the Banking Sector



Lao Kam Chio






Abstract


The Macao financial market has a relatively simple structure. The banking sector
plays a dominant role whose gloom and boom is largely driven by the interaction of
several factors, namely changes in demand for bank finance, regional economic cycle
and supervisory environment. Market structure assessment helps to identify
information such as the potential and limitation of the financial industry, which helps
to map out strategy geared to future market development. This paper attempts to
carry out a basic study of the banking sector through the application of theories
relating to market structure. It will also recommend several strategies conducive to
improving or enhancing performance of the banking sector.



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Market Structure and Business Development Strategy of the Banking Sector

1. An Overview of the Performance of the Banking Sector

A statistical study of the banking performance shows that during the past decade the
sector has experienced a process characterised by profitability deterioration to
recuperation. The situation is particularly obvious in the early 1990s when the
Mainland government implemented a series of austerity measures, resulting in
massive early recall of investment in Macao’s property sector. Many development
projects were put to halt or disrupted due to lack of capital. Consequently, loans
extended by the banking sector could not be repaid, leading to a huge accumulation of
non-performing loans.

Chart 1 illustrates the change in profitability of the Macao banking sector during the
past 10 years. From 1995 to 2004, lending was sluggish and this was generally
understood to be the result of non-performing loans arising from reasons mentioned
above. Accordingly, the banks became more prudent and in some cases, overly
stringent on credit assessment. Coupled with a prolonged period of low credit
demand, interest spread income from traditional banking business was severely
impaired.

To offset stagnation in traditional banking business, many local banks broadened their
revenue base by offering fee-based service. Along with gradual recovery of the
economy, banks managed to recover many bad debts. This situation had two
outcomes. First, it helped to reduce the outstanding balance of non-performing loans.
Second, it alleviated the banks from making further bad debt provision. The
combined effect of these favourable factors has allowed the Macao banking sector to
regain strength with rising profitability in recent years.







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Market Structure and Business Development Strategy of the Banking Sector

Chart 1: Changes in Profitability of the Banking Sector,
MOP billion
1995 - 2004
20
15
10
5
0
19
1
1
1
1
2
2
2
2
2
9
9
9
9
9
0
0
0
0
0
5
96
97
98
99
00
01
02
03
04

Source: Monetary Authority of Macao.


2. Structure of the Macao Banking Sector

The Macao financial sector is recognised as one of the important economic pillars
with properly developed foundation. Operating in a tourism and gaming oriented
environment, further development of the banking sector may promote economic
diversification. Benefiting from an improvement in loan demand, the sector has
huge potential for further growth. Gradually, the sector manages to develop its
unique market structure as a result of the development process. Through an analysis
of the market structure of the local financial sector, its general situation and features
can be elucidated below.

2.1 Formation, cause and feature of over-concentration

The term – over-concentration - will always ring the bell when it comes to describing
the situation of the Macao banking sector. Basically, this term pinpoints the
deposit/loan business of the banking sector.

For a long time, the behaviour of Macao residents can be described as traditional
which extends to banking service. Many people have preference for locally
incorporated banks or banks of Mainland capital. It is not surprising that a good
chunk of loan and deposit business is handled by Portuguese and Chinese banks.
These banks have also established presence in the neighbourhood of their clients with

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Market Structure and Business Development Strategy of the Banking Sector

the intention to secure or expand customer base. Many banks are willing to
introduce comprehensive banking service through investment in branch network
while retail banking is the mainstream in the sector.

To show the degree of concentration, indices of absolute and relative concentration
are employed. The result shows that, statistically, banking business here is highly
concentrated. There is a formula for computing absolute concentration. We take
the sum of market share of n largest companies. The formula is as follows:

n
∑ Xi
CRn
i =
= 1

X


where,

n = number of banks;
Xi = total deposit (excluding public sector) or total loan (excluding credit
against stocks, bonds and commercial papers) of bank i in the market;
X = total deposit or total loan of all the banks in the market;
CRn = market share index of n banks which carry the highest weights;
CRnd & CRnl = deposit and loan indices of n banks carrying highest weights.

When the data of deposit and loan of the banking sector for 1995 and 2004
respectively are plugged into the formula, CR4d for four banks with highest market
share are 0.71 and 0.66 while CR4l are 0.6 and 0.58, which are close to the
monopoly digit of 1. Concentration prevails in the Macao banking sector in the past
decade and there has been little change. There were a total of 22 and 23 banks in
operation in the year 1995 and 2004 respectively.





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Market Structure and Business Development Strategy of the Banking Sector

Hirschman-Herfindahl Index, HI, can also be used to further validate the degree of
concentration. HI is a composite index for market structure used to measure the
degree of industry concentration. The formula is as follows:

HI = ∑ (Xi/X)² i=1, 2…n,

Similarly, the result of the computation also shows over concentration.
Chart 2: Deposit and Loan of the Banking Sector ,
MOP billion
1995 - 2004
1500
1200
900
600
300
0
19
1
1
1
1
2
2
2
2
2
9
9
9
9
9
0
0
0
0
0
5
96
97
98
99
00
01
02
03
04
總存款
Total deposit
總貸款
Total loan

Source: Monetary Authority of Macao.

2.2 Stringent entry and exit barriers imposed by regulatory authorities

In the early 1980s, the Portuguese Macao government restructured the banking
supervision department, which was under the Director of Finance Services, into an
autonomous issuing institute (IEM), which was the predecessor of the Monetary
Authority of Macao. Since then, the banking regulator has enforced a comparatively
more stringent market entry and exit mechanism.

According to the provision of the banking law, entities wishing to conduct banking
business in Macao must obtain licence by submitting application, with final approval
vested in the hand of the Chief Executive. The prescribed capital requirement for
applicants is not high. It would be more difficult to satisfy assessment criteria such
as applicant’s qualifications and potential contribution to the local financial sector
than to merely meet the minimum capital requirement.


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Market Structure and Business Development Strategy of the Banking Sector

Since the 1980s, the Monetary Authority of Macao has implemented a series of
guidelines, by following closely new standards adopted by international regulatory
bodies with modification to accommodate the local financial market. A stringent
market entry and exit mechanism has been included. A high standard has been
established for the banking sector which is governed by tough entry and exit
mechanism in full compliance with international standards.

2.3 Homogenous core business with similar product characteristics

As mentioned earlier, one of the characteristics of the banking sector is that its
business is rather traditional and homogeneous. Deposit and loan remain the major
source of revenue while the latter is highly concentrated on a number of customers.
Thus, banking products tend to be similar with little differentiation. Take bank credit
for example, business lending ranks first, followed by mortgage and credit card
financing. Product similarity results in high interdependence among counterparts
and oligopolistic operation. Besides, competition among several major banks is
severe as this is a long-term competition for the same customer base.

2.4 Few market players with large scale operation

As at the end of last year, there were a total of 23 banks authorised to operate in
Macao. Based on area and population, Macao has a high density banking network.
On average, one branch office serves around 3,500 customers. Nevertheless, most of
them are some small offices equipped with 3 counters. In fact, there are not many
large scale credit institutions in Macao. Therefore, banks that can marginally
classified as big have competitive edge in capital, know-how and reputation.

Given the factors mentioned above, larger credit institutions have already secured
substantial market share, which creates barriers to new entrants. It is worthwhile
mentioning that many banks in Macao are indeed branches of world renowned banks.
Despite the fact that their parents have world class operation network and capital, their


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Market Structure and Business Development Strategy of the Banking Sector

business scope is rather limited as long as they maintain same kind of service station
presence in Macao.

2.5 The Macau Association of Banks controls pricings

The Macau Association of Banks is an organisation established at the initiative of the
banking sector with management position assumed historically by market leaders on
rotation basis. It has no statutory power over industry practices. However, interest
rate adjustments developed through collective discussion are closely followed by
banks in Macao. In addition, fees levied by banks are made uniform through the
platform of the association by express understanding instead of putting it in black and
white. Under the coordination of the association, it is undeniable that the banking
sector in Macao is applying an uniform pricing policy.

Based on the model of market structure and the above analyses, the structure of the
banking sector in Macao can best be described as oligopolistic with the following
features:

(i)
High market concentration;
(ii)
High entry and exit barriers;
(iii)
Little product differentiation;
(iv)
Few large scale enterprises (given the small market there are relatively
numerous competitors);
(v)
High degree of control on pricings.












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Market Structure and Business Development Strategy of the Banking Sector

Table 1: Market Structure and Characteristics

Market
Concentration Entry
Product
No. of
Pricing
structure
barrier
differentiation entities
control
Perfect
Low Low No
Massive
No
competition
Monopolistic Relatively low Relatively
Yes Many
Moderate
competition
low
Oligopolistic Relatively high Relatively
Yes or no
Several
Certain
competition
high
extent
Monopoly High High One One
Large
extent
Source: Wong Wing Chit (January, 2004).

The local banking sector has not achieved a market with perfect competition. As such,
competition is less strenuous when compared with industry operating under
conditions of perfect competition. Perhaps, this situation is well perceived by many
banks which choose to pursue a more conservative marketing strategy. Nevertheless,
viewing the future from another perspective, it appears that an objective environment
conducive to developing benign competition exists in the market.


3. Development Strategy of Oligopolistic Industry

It is painstaking to operate in an oligopolistic industry characterised by high market
concentration and confronting challenges from counterparts. As such, supervisory
authorities should make the market players understand that there is room for
development even in a highly concentrated market and encourage them to develop
feasible and appropriate development strategies by exploiting objective and subjective
market factors.

3.1 Win customer loyalty by making full use of human resources

In the banking sector, there exists executives equipped with solid financial and
management expertise. They are capable of mapping out appropriate strategies even

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Market Structure and Business Development Strategy of the Banking Sector

under extremely competitive market condition. It might be difficult to revolutionise
the oligopolistic situation in the offing. However, they can make use of their
expertise and enthusiasm in leading their staff to attain new accomplishments. The
banking sector has gone through many ups and downs during the past decade. It is
indeed a blessing to have a team of socially responsible managers with entrenched
management experience to help the banks overcome difficulties and turnaround.

Competition acts as a catalyst in enhancing efficiency of the banking sector. In
recent years, many people with college education have joined the banking sector.
Along with different training programmes implemented to enhance knowledge of
modern banking operation, professional standard of the sector is basically being
enhanced. The banking sector in Macao has a team of professionals capable of
confronting challenges. With further effort directed to training, strengthening
internal risk control mechanism and broadening business potential, the banking sector
is expected to experience enhancement in competitiveness and achieve favourable
return.

The banking sector is used to be passive in operation. In recent years, many banks
have adopted a more proactive role by establishing temporary offices at the site of
new building to solicit new clients. Professionalism and warm attitudes of the
banking representatives are impressive. Apart from that, the sector also manages to
modernise its image and earn favourable return by introducing new services, such as
flexible financial planning, customised financing and expedient shares and remittance
settlement. Comparing with monotonous print advertisement, courteous attitude of
the banking professionals is more effective in winning customer loyalty.

3.2 Broaden business potential and customer base to make a breakthrough

Continuous improvement in profitability has been noted in the banking sector in
recent years. Apart from objective factors such as recovery of substantial amount of
bad debts, the introduction of fee income service also helps to significantly boost
profitability. It is recommendable for banks to develop financial derivatives to increase

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Market Structure and Business Development Strategy of the Banking Sector

income in a highly concentrated market. The attempt exploits new source of revenue
and allows a breakthrough in business development.

In an oligopolistic market, banks with the objective to broaden business scope have to
cope with many limitations such as collusion among oligopolists. This kind of long
term concerted effort has suppressed positive competition and contained market
agility. Internally, the banks need to tackle challenges posed by imbalance between
loan and deposit brought about by limited market and slack demand for bank finance.
Some foreign banks are over cautious in capital commitment and look upon their
branches as just service stations. Local banks may have limitation in sourcing new
capital. It is imperative for banks to adopt a focusing strategy if they intend to break
away from these limitations. Otherwise, it would be difficult for them to elevate
their business to a higher level.

To address the issue of market limitation, the MSAR government has incessantly
encouraged the sector to establish business relationship in the Mainland loan market,
particularly the Pearl Delta River and Guangdong West. Banks should seek new
opportunities through syndication and equity investment in Mainland banks.
Besides, foreign banks with subsidiaries in Macao need to be reminded the potential
of the market and change their mindset by actively participating in local financing and
make full use of their international reputation and brand name. As regards local banks,
some of them have the options to enhance competitiveness and respond to new market
development by introducing strategic partners or selling their own equity.


4. Conclusion

Given the uniqueness of banking operation, it would be inappropriate to
superimposing general business operational model on the banking sector although
they have the same objective of profit maximisation. Having experienced decades-
long transformation, the banking sector has now developed into an oligopolistic
industry. To succeed in a highly concentrated market, it requires painstaking effort

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