La opinión y la tertulia en COPE Valencia El caso de ‘El

Since the year 2001, the Malaysian authorities have been embarking on far-reaching reforms of the financial system led by four 10-year masterplans, namely the Financial Sector Masterplan (FSMP) and the parallel Capital Markets Masterplan (CMP) 1 for the period 2001 to 2010, the Financial Sector Blueprint and CMP 2 for the period 2011 to 2020 (BNM, 2001, 2011a; SCM, 2001, 2011). The reform initiatives are implemented gradually in phases, of which deregulation and liberalisation of the banking sector and stock market have been highly focused on since the second phases of FSMP and CMP1 (2004-2005), as part of initiatives to promote a competitive, diversified and more market- oriented financial system. Examples of banking deregulation and liberalisation measures are interest rate deregulation, relaxation of bank branching restrictions and issuance of new licenses to foreign and Islamic banks (BNM, 2001). In principle, the benefits of competition for efficiency, service quality provisions and innovation in banking are no different than in any other industry – which is probably the basis of the global trend towards greater competition in the banking industry (Allen & Gale, 2000; Vives, 2001). However, the banking industry has some specificities that may affect the desirability of competition in the industry, for example, a fragile financial position and information asymmetry (Vives, 2001). Since the Malaysian economy relies on its banking system to provide and, thus, to create liquidity for economy financing, if the liquidity creator role of the banks is weakened due to any inconsiderate policy implemented, there are catastrophic real effects on the economy. Hence, the fourth research objective aims to draw policy implications from the findings in order to assist the ongoing formulation, implementation and monitoring of policies related to bank competition and stock market development.

Commercial banks in Malaysia have been operating in a monopolistic competition environment, even before the FSMP implementation in 2001 (Abdul-Majid & Sufian, 2006). While supporting the monopolistic competition structure, the descriptive results based on the Lerner Index of pricing power of this study demonstrate that the average market power of individual Malaysian commercial banks has been receding since the year 2004, signalling the efficacy of deregulation and liberalisation initiatives implemented in the industry. The descriptive results also show that large Malaysian commercial banks possess significantly larger pricing power than small banks. The disparity in the pricing power appears to be more evident in the credit market than in the deposit market, owing to the competitive deposit market reported earlier in our study and the IMF (2014). The greater loan pricing of large banks than small banks can be explained through the types of market segments they serve because different market segments have different sources of competition. In Malaysia, large banks serve a wider scope of borrowers ranging from households and retail to business corporates, compared to corporate financing narrowly focused on by small banks. At the household and retail

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banking levels, market contestability tends to be lower and locally-oriented owing to high entry barriers exerted by incumbent banks, such as reputations and the branch network, making room for large banks to exercise market power (Vives, 2001). On the other hand, the game in the business banking market tends to be competitively intense because business corporates have wider financing choices from banks, non-bank financial institutions and capital markets, both locally and globally (Vives, 2001). This explains why small banks that narrowly focus on corporate customers generally have relatively lower market power than large banks.

Indeed, with the presence of information asymmetry in banking, the regression results of our study show that the repression effect of an increase in bank competition on liquidity creation is apparent in the Malaysian commercial banking industry today, and this effect carries through to small banks. According to the fragility channel view, some degree of market power in banking is desirable to address the liquidity needs of economic agents such as borrowers and depositors (Petersen & Rajan, 1995; Dell’Ariccia & Marquez, 2004; Horvath et al., 2013, 2016). A bank with market power has greater incentive to invest in information acquisition about their customers and monitor them by granting loans and maintaining relationships with them, because the bank has greater ability to capture the customers and share in their wallets. This effect tends to reduce credit rationing to the public, which is especially valuable for informationally-opaque customers. Our study findings offer implications for policy makers that, some market power in banking is good, particularly when the economy is heavily reliant on the banking system for the liquidity supply and facilitation of the development of nascent industries and firms. Indeed, our additional results in Section 5.4.2 further indicate that the collective banking deregulation and liberalisation initiatives implemented in the Malaysian banking sector since the year 2004 has a negative effect on bank liquidity creation.

Besides, our regression results also indicate that an increase in competition has the traditional industrial organisation effect of compressing interest margins on both the asset and liability sides of banks and increasing liquidity creation undertakings to gain greater market share. This effect is, however, mild and evident only for large banks with substantial capacity for liquidity creation, for example, banks that have large market share and extensive branch networks throughout the country. When facing an increase in competition, large banks with high market power at household and retail banking levels, such as Maybank, are able to tolerate a lower interest spread to leverage their liquidity creation business in existing and new consumer markets (Lim, 2015). The findings imply that a competition policy has a role to play at the retail banking level and may be desirable in improving underserved customers’ access to bank products and services. In this case, regulators should also monitor banks’ pricing policies to ensure the policies adhere to the approved risk

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appetite and risk management framework of the banks and industry. Such a ‘risk-based pricing’ strategy helps to thwart banks’ unethical product mispricing through cross-subsidisation, protecting the welfare of bank customers (Vives, 2001). Owing to the size of large banks and the high social costs of failure, competition in the banking industry should be restricted when risk positions (for instance, the credit risk position) of banks are being compromised and there is failure to abide by the Basel Accord III on capital, leverage and liquidity requirements. Competition policies will certainly be exploited by large banks for excessive risk-taking undertakings because credit rationing to risky customers is reduced. While lower market power enhances liquidity creation by large banks, our findings suggest to policy makers that a higher level of market power can be more tolerated in banking than in other industries as competition is often associated with financial instability in banking (Berger et al, 2009; Fu et al., 2014; Kasman & Kasman, 2015; Vives, 2001).

In addition, the different effect of bank competition on liquidity creation between small and large banks also raises interesting policy implications. Competition has reduced small banks to a process of value differentiation in the liquidity creation role. This implies that small banks that do not create liquidity when encountering a rise in competition are finding themselves increasingly marginalised from the mainstream of liquidity creation activity dominated by large banks. Without greater scale, small banks’ competitive position is not as compelling as bank customers seek financial solutions in a safe and steady name with a sustainable business in Malaysia. Hence, it is important for small banks to build scale, implement appropriate technological and value-added solutions and adapt their branding strategies and business models to weather the adverse impact of competition on their liquidity creation role in the economy, unless their shareholders are in for a long game of low margins to pursue other meaningful business objectives. While acknowledging the development of a competitive banking sector is a confluence of economic, technological and regulatory factors as well as the uprising Islamic banking in the context of Malaysian banking sector, this study suggests greater regulatory leeway and protection for small banks when designing banking competition policy for the highly concentrated Malaysian banking sector. This can be helpful in providing headroom for small banks to strengthen their competitiveness and in deterring heavyweight banks from abusing their market dominance in a way that smaller banks cannot. For instance, given the fact that small banks in Malaysia target niche markets and offer personalised products and services, their existence in the market can create a competition of service quality which prompts large banks to enhance their service quality. An inconsiderate competition policy can lead to an imbalanced development of the banking industry in the long term, as the liquidity creation function of small banks may not be sustainable in the competitive financial landscape.

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In terms of the stock market liquidity, the descriptive results do not show any evident improvement of the market liquidity in Malaysia over the short time span from 2001 to 2013. The effectiveness of the reform measures on stock market liquidity requires a longer-term surveillance because the market has had a long history of illiquidity compared to other ASEAN peer averages and the world average. Besides, the correlation analysis shows that the turnover ratio, which is commonly used by regulators, is a weak proxy for the stock market liquidity because it does not have significant correlations with quoted bid-ask spread and Amihud’s illiquidity ratio which measure the transaction cost and the breadth and depth of the stock market, respectively. The regression results using turnover ratio also show contradictory results to those using alternative stock market liquidity measures. As has been reported by previous studies, turnover ratio measures the trading activity on the market, but it does not necessarily reflect changes in the trading costs that correlate with stock price volatility which can impede the market liquidity (Fleming, 2003; French & Roll, 1985; Lesmond, 2005; Rouetbi & Mamoghli, 2014). It is, thus, important for policy makers to look at a broad set of indicators when gauging stock market liquidity conditions, instead of relying solely on the market turnover ratio.

Overall, the regression analyses show that an increase in stock market liquidity does improve liquidity creation by commercial banks in Malaysia. This finding implies that further policy initiatives that address the structural impediments on market liquidity and liberalise market access for intermediaries, issuers and investors are encouraged. This is because a liquid stock market does not only facilitate more effective mobilisation and allocation of funds through the role of the stock market, but also stimulates liquidity creation undertakings of banks for a wider scope of customers in catering for the nation’s growing financing needs.