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The competition and market structure in the Saudi Arabia banking

Saeed Al-Muharrami
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JES
36,5
446
Received 18 June 2007
Accepted 6 May 2008
Journal of Economic Studies 2009.36:446-460.
Journal of Economic Studies
Vol. 36 No. 5, 2009
pp. 446-460
q Emerald Group Publishing Limited
0144-3585
DOI 10.1108/01443580910992375
The current issue and full text archive of this journal is available at
www.emeraldinsight.com/0144-3585.htm
The competition and market
structure in the Saudi Arabia
banking
Saeed Al-Muharrami
Sultan Qaboos University, Al-Khod, Sultanate of Oman
Abstract
Purpose – The purpose of this paper is twofold: to investigate the market structure of Saudi Arabia
banking industry; and to evaluate the monopoly power of banks during the years 1993-2006.
Design/methodology/approach – The paper is examining the market structure using the most
frequently applied measures of concentration k-bank concentration ratio (CRk) and
Herfindahl-Hirschman Index (HHI) and it is evaluating the monopoly power of banks using the
“H-statistic” by Panzar and Rosse.
Findings – The results show that Saudi Arabia has a moderately concentrated market and is moving
to a less concentrated position. Both the concentration indices indicate that the country is moving
toward a better position in terms of the market concentration. The Panzar and Rosse “H-statistic”
suggests that banks in Saudi Arabia operate under monopolistic competition.
Research limitations/implications – These findings may be a temporary effect, evident during
the sampled period only. To draw firmer conclusions a longer sample period is needed.
Originality/value – Studies of banking market structure in the developed economies’ banking are
commonplace, however, very few studies are conducted for Saudi Arabia’s banking industry.
Keywords Saudi Arabia, Banking, Market system, Monopolies, Competitive strategy
Paper type Research paper
1. Introduction
A sound and efficient financial system is the most important prerequisite for savings
and investment decisions and thus economic growth. Economists have long recognised
that financial markets in general, and banks in particular, play a vital role in
the efficient functioning and development of any economy. In developing countries, the
development of the banking and financial system may reflect the extent of importance
given by the country to this vital sector, which can be largely relied upon to
achieve the desired growth in the national economy. The performance of financial
institutions is crucial for the well-being of the whole economy and has attracted the
attention of many researchers. Odedokun (1998) estimated with cross-sectional data
over the 1970s and 1980s for 90 developing countries including Saudi Arabia and the
main finding is that: financial intermediation exerts positive effects on economic
growth in developing countries.
In the early 1970s, many foreign banks had entered the Saudi Arabia banking
system, attracted by the opportunities brought about by the boom in the economy
JEL classification – G21, L1, D40
The author is grateful to the anonymous referee and the Editor for helpful comments and
advice. The author is responsible for all remaining errors.
 resulting from the increased oil revenues, especially from 1973 onwards. The strong Competition and
presence of foreign banks, of which there were ten by the mid-1970s, encouraged the market structure
Saudi authorities to introduce a policy encouraging foreign banks to be converted into
publicly traded companies with the participation of Saudi nationals. The legislation
introduced in 1975 aimed to preserve the rights and interests of foreign banks’
positions as partners in the newly incorporated banks. In order to maintain the
performance and stability of the banking sector, foreign banks were allowed to hold up 447
to 50 per cent ownership and include the name of their origins in the bank title (for
example, the Saudi British Bank and the Saudi American Bank). They could also
maintain management responsibilities and were allowed to enjoy treatment equal to
that of national banks (Saudi Arabia Monetary Agency (SAMA) 1998).
Therefore, the significant changes in the Saudi Arabia banking industry raise the
important policy concerns that banks in highly concentrated markets should gain market
power due to being able to charge higher than competitive prices for their products, thus
inflicting welfare costs that could more than offset any presumed benefit associated with
mergers. Other concerns regarding the higher concentration ratio (CR) include such
problems as the limited effectiveness of monetary and credit policy, increased probability
Journal of Economic Studies 2009.36:446-460.

of systemic risk, and reduction in lending to small and medium corporations.

The paper is trying to assess the market structure and the competitive condition of
the Saudi Arabia banking industry. It also tries to answer the question: should
concentration in the Saudi Arabia banking industry cause a big concern? Therefore,
the two aims of this paper are to investigate the market structure of Saudi Arabia
banking industry using the most frequently applied measures of concentration k-bank
concentration ratio (CRk) and Herfindahl-Hirschman Index (HHI). The second aim is to
evaluate the competitive conditions of the Saudi Arabia banking industry using the
“H-statistic” by Panzar and Rosse during the years 1993-2006.
The organization of the paper is as follows. Section 2 presents the background and
the growth of the banking sector in Saudi Arabia. Section 3 presents the literature
review while Section 4 describes the methodology and data. Section 5 shows the results
and Section 6 summarizes the paper with the concluding remark.

2. Banking sector development in Saudi Arabia

Early banking activities in Saudi Arabia were limited to the presence of a handful of
foreign-based trading houses, such as the branch of Algemene Bank Nederland, and of
various money changers (Al-Jarrah, 2002). Their main business was to provide
financial services for locals and pilgrims. The more formal and organised form
of banking system emerged after the exploration of oil in 1939 and, as soon as
World War II ended, the Saudi market attracted leading foreign banks to open
branches. Hence, the French Banque de l’Indochine and Arab Bank Limited opened
their branches in Jeddah in 1948; while in 1950, three international banks opened their
braches, namely the British Bank of the Middle East, the National Bank of Pakistan
and Bank Misr (of Egypt).
Moreover, Saudi Arabia did not have a national currency until 1952, a year that
witnessed the establishment of the SAMA (Al-Jarrah, 2002). However, over the years
1950 and 1956, SAMA introduced a paper money in the form of pilgrim receipts, which
was covered by foreign currencies and precious metals. The introduction of the Saudi
national currency, called the riyal, came in 1960.
 JES During the 1980s, various other national banks were established, including Al-Rajhi
36,5 Banking and Investment Corporation (the largest money exchanger licensed as a full
commercial bank), Saudi Investment Bank (authorised as a full commercial bank with
foreign ownership reduced to 25 per cent and the remaining shares sold to the public),
and the United Saudi Bank (formed after the take-over of three foreign banks). These
banks contributed to the restructuring of the Saudi banking sector. Meanwhile, SAMA
448 encouraged banks to strengthen their capital positions so as to improve the soundness
of the system (Al-Sahlawi, 1997; Al-Jarrah, 2002).
The second half of the 1990s witnessed a merger between the United Saudi
Commercial Bank and the Saudi Cairo Bank, to form the United Saudi Bank. The United
Bank also merged with the Saudi American Bank in 1998. Moreover, Saudi banks
continued to embrace operational development by investing in new technologies such as
electronic funds transfer systems and by setting up widespread point-of-sale terminals.
From mid-1975, no new foreign bank entities have been allowed to enter the Saudi
banking system. However, in the move towards Gulf Cooperation Council (GCC)
financial sector integration, many of the GCC banks opened branches and others have
been lately granted licenses to open branches on Saudi soil.
Journal of Economic Studies 2009.36:446-460.

2.1 Growth of Saudi Arabia banking sector

Overall, the Saudi financial system, the largest in the Gulf region, has witnessed a
remarkable expansion in banking accompanied by ongoing updating and revision of
its regulatory framework to ensure increased soundness and prudence in the banking
system. Table I shows the growth of the total assets of local commercial banks by
171 per cent from 1993 to 2006.
Saudi Arabia commercial banks have expanded their branch networks
considerably, from 1,106 branches at end 1993 to 1,243 at end of 2006 with a growth
rate of 12.4 per cent as is shown in Table II. This paper will answer the question
whether Saudi Arabia is over or under branched?

3. Literature review
3.1 Measuring market structure
There are a number of measures of concentration that have been used in banking
studies. Hall and Tideman (1967) suggested a list of six desirable properties for
measures of concentration. These are:

Year 1993 1995 1997 1999 2001 2003 2005 2006 D 1993-2006

Total 301,607 316,283 356,091 413,394 461,271 540,079 723,838 817,006 þ 171%
Table I. Note: Million Saudi riyal
Total asset Source: Compiled by the author from banks annual reports

Year 1993 1995 1997 1999 2001 2003 2005 2006 D Branches 1993-2006
Table II. Total 1,106 1,116 1,125 1,168 1,176 1,190 1,211 1,243 12.4%
Branches of banks
in Saudi Arabia Source: Compiled by the author from banks annual reports
 (1) a concentration index should be a one-dimensional measure; Competition and
(2) concentration in an industry should be independent of the size of that industry; market structure
(3) concentration should increase if the share of any firm is increased at the
expense of a smaller firm;
(4) if all firms are divided into K equal parts then the concentration index should be
reduced by a proportion 1/K; 449
(5) if all firms are divided into N equal parts then the concentration should be a
decreasing function of N; and
(6) a concentration measure should be between zero and one.

In a review of 73 US Structure-Conduct-Performance studies from 1961 to 1991,

Molyneux et al. (1996) report that in 37 studies, the three-bank deposits concentration
measure was used. The second most frequently used is the Herfindahl-Hirschman
Index (HHI – 18 studies) followed by the number of firms in the market. Following the
steps of these measures and due to the limited number of banks in GCC, this paper uses
the highest two- and three-bank deposits as well as HHI for deposits as a measure of
Journal of Economic Studies 2009.36:446-460.

market structure.
3.1.1 The k-bank concentration ratio. Simplicity and limited data requirements
make the k-bank concentration ratio one of the most frequently used measures of
concentration in the empirical literature. Summing only the market shares of the k
largest banks in the market, it takes the form:
X
k
CRk ¼ MSi
i¼1
where MS is the market share of the ith firm and k is number of the biggest firms in the
market.
The index gives equal emphasis to the k leading banks, but neglects the many small
banks in the market. There is no rule for the determination of the value of k, so that the
number of banks included in the concentration index is a somewhat arbitrary decision.
The CR may be considered as one point on the concentration curve, and it is a
one-dimensional measure ranging between zero and unity. The index approaches zero
for an infinite number of equally sized banks (given that the k chosen for the
calculation of the CR is comparatively small when compared to the total number of
banks) and it equals unity if the banks included in the calculation of the CR make up
the entire industry.
3.1.2 The Herfindahl-Hirschman Index. Policy makers in the US Department of
Justice have for many years published formal guidelines that identify structural
changes resulting from mergers that are likely to cause the department to challenge a
merger. Since 1982, the department has based its merger guidelines on the HHI of
concentration. This measure, which is also used by bank regulatory agencies, is
calculated by squaring the market share of each firm competing in a defined
geographic banking market and then summing the squares. The HHI can range from
zero in a market having an infinite number of firms to 10,000 in a market having just
one firm (with a 100 per cent market share).
According to the current screening guidelines in the USA, the banking industry is
regarded to be a competitive market if the HHI is less than 1,000, a somewhat
 JES concentrated market if the HHI lies between 1,000 and 1,800, and a very concentrated
36,5 market if HHI is more than 1,800. If the post merger market HHI is lower than 1,800
points, and the increase in the index from the pre-merger situation is less than 200
points, the merger is presumed to have no anticompetitive effects and is approved by
the regulators. Should these threshold values be exceeded, the regulators will check for
the existence of potential mitigating factors. If the mitigating factors are not enough to
450 justify the merger, the regulators may require the divestiture of some branches and
offices, in order to bring the CR to or below the threshold level. If divestiture would not
accomplish this goal, the merger application is denied.
The HHI index was developed independently by the economists A.O. Hirschman
(in 1945) and O.C. Herfindahl (in 1950) (Rhoades, 1993). The HHI is a static measure
and, therefore, gauges market concentration at a single point in time. Algebraically, it
can be depicted as:
X
n
HHI ¼ ðMSi Þ2
i¼1
Journal of Economic Studies 2009.36:446-460.

where MS is the market share of the ith firm and n is number of firms in the market.
The HHI stresses the importance of larger banks by assigning them a greater weight
than smaller banks, and it incorporates each bank individually, so that arbitrary
cut-offs and insensitivity to the share distribution are avoided.
Based on the number of national banks, the researcher expects that the two- and
three-bank deposits and HHI value for testing the market structure will give
indications that Saudi Arabia market could be described as “unconcentrated market”.

3.2 Measuring competitive condition

The view on the relationship between competition and market structure is based on the
traditional monopoly power hypothesis, which suggests that more concentrated
markets tend to be more collusive, generating market power which allows banks to
earn monopolistic profits by offering lower deposit rates and charging higher loan
rates.
These arguments, so-called “structural models” are challenged by other theoretical
approaches. In reaction to the theoretical and empirical deficiencies of the structural
models, “non structural models” of competitive behaviour have been developed. These
New Empirical Industrial Organization approaches such as the Iwata model, the
Bresnahan model, and the Panzar and Rosse model measure competition and
emphasize the analysis of the competitive conduct of banks without using explicit
information about the structure of the market.
This study employs one of the “non-structural model” approach suggested by Rosse
and Panzar (1977) and Panzar and Rosse (1982, 1987), so-called “H-statistic”, which has
been widely employ for the examination of the competitive structure of the banking
industry in various countries, in order to investigate the market structure of Saudi
Arabia banking industry during the periods of 1993-2006.
In the banking industry there has been growing attention toward the application of
the Panzar-Rosse methodology. Shaffer (1982), in his pioneering study on New York
banks, observed monopolistic competition. For Canadian banks, Nathan and Neave
(1989) found perfect competition for 1982 and monopolistic competition for 1983-1984.
Lloyd-Williams et al. (1991) and Molyneux et al. (1996) revealed perfect collusion
 for Japan. Molyneux et al. (1994) tested the P-R statistic on a sample of French, German, Competition and
Italian, Spanish and British banks for the period 1986-1989 in order to assess the market structure
competitive conditions in major European countries (EC) banking markets. They
obtain values for H which is not significantly different from zero and from unity for
France, Germany (except for 1987), Spain and the UK, thus pointing to monopolistic
competition. The H-statistic for Italy during 1987-1989 is negative and significantly
different from zero; hence it was not possible to reject the hypotheses of monopoly. 451
Coccorese (1998), however, who also intends to evaluate the degree of competition in
the Italian banking sector, obtains significantly non-negative values for H. H was also
significantly different from unity, except in 1992 and 1994. Vesala (1995) applies the
model to the Finnish banking industry (1985-1992) to test for competition and market
power in the Finnish banking sector. His estimates of H were always positive, but
significantly different from zero and from unity only in 1989 and 1990. For
Switzerland, Rime (1999) observed monopolistic competition. Bikker and Groeneveld
(2000) determine the competitive structure of the whole EU banking industry. The
estimated values for the H-statistic lie between two thirds and one in most countries.
The hypothesis 0 ¼ H is rejected for all countries, whereas 1 ¼ H cannot be rejected
Journal of Economic Studies 2009.36:446-460.

for Belgium and Greece at the 95 per cent confidence level. de Bandt and Davis (2000)
investigate banking markets in France, Germany and Italy within groups of large and
small banks. Aiming to assess the effects of Economic and Monetary Union on market
conditions, they obtain estimates of H, which are significantly different from zero and
from unity for large banks in all three countries. The H-statistics estimated for the
sample with small banks indicate monopolistic competition in Italy, and monopoly
power in France and Germany. Bikker and Haaf (2000) consider banks in 23
Organisation for Economic Co-operation and Development (OECD) countries and
investigate small, medium-sized and large banks separately. This P-R analysis finds
monopolistic competition virtually everywhere, although perfect competition cannot be
rejected for some market segments.
Al-Muharrami et al. (2006) evaluate the monopoly power of GCC banks over ten
years period, 1993-2002, using the “H-statistic” by Panzar and Rosse. The results show
that banks in Kuwait, Saudi Arabia and UAE operate under perfect competition; banks
in Bahrain and Qatar operate under conditions of monopolistic competition; and they
were unable to reject monopolistic competition for the banking market in Oman.
Gunalp and Celik (2006) employed the Panzar-Rosse H-statistic to assess the
competitive environment of the Turkish banking industry over the period 1990-2000.
The results indicated that for the period under consideration bank revenues behaved as
if they were earned under conditions of monopolistic competition. Therefore, the
observed high profitability of the Turkish banking sector was not an indication of an
increase in monopoly power. Perera et al. (2006) examines the nature of competition
and structure in South Asian banking markets. The Panzar-Rosse specification tests
show that banks revenues appear to be earned under monopolistic competition during
the period 1995-2003.
Finally, Yildirim (2007) examines the evolution of competitive conditions in the
banking industries of 14 Central and Eastern European (CEE) transition economies for
the period 1993-2000. The results of the competition analysis suggest that the banking
markets of CEE countries cannot be characterized by the bipolar cases of either perfect
 JES competition or monopoly over 1993-2000 except for Federal Yugoslavia Republic of
36,5 Macedonia and Slovakia.
Table III summarises the results of those investigations. Most of them are for EC
and indicate that banks earn revenues as if they are under conditions of monopolistic
competition.

452 4. Methodology and data

4.1 The Panzar and Rosse approach
The method developed by Panzar and Rosse (1987) determines the competitive
behaviour of banks on the basis of the comparative static properties of reduced-form
revenue equations based on cross-section data. Panzar and Rosse show that if their
method is to yield plausible results, banks need to have operated in a long-term
equilibrium (i.e. the number of banks needs to be endogenous to the model) while the
performance of banks needs to be influenced by the actions of other market participants.
Furthermore, the model assumes a price elasticity of demand, e, greater than unity, and a
homogeneous cost structure. To obtain the equilibrium output and the equilibrium
number of banks, profits are maximised at the bank as well as the industry level.
Journal of Economic Studies 2009.36:446-460.

Few assumptions need to be made to apply this model in this study. First, one needs
to assume that banks can be treated as single product firms (de Bandt and Davis, 2000);
consistent with the intermediation approach to banking, banks are viewed as
producing intermediation services using labour, physical capital and financial capital
as inputs. Second, one needs to assume that higher input prices are not correlated with
higher quality services that generate higher revenues, because such a correlation could
bias the computed H-statistic. This means, however, that if one rejects the hypothesis
of a contestable/competitive market, this bias cannot be too large (Molyneux et al.,
1996). Third, one needs to be observing banks in long-run equilibrium. Therefore, this
study tries to overcome this problem by using a panel data specification.

4.2 The empirical model

Following Shaffer (1982, 1985), Nathan and Neave (1989), Molyneux et al. (1994) and
Hondroyiannis et al. (1999), the paper estimates the following bank revenue equation in
which revenue is explained by factor prices and other bank-specific variables that
affect long-run equilibrium bank revenues for Saudi Arabia banks during the years of
1993-2006:

LnTREV ¼a0 þ ða1 ln PL þ a2 ln PK þ a3 ln PFÞ þ a4 ln RISKAST

ð1Þ
þ a5 ln ASSET þ a6 ln BR

The justification for using the log linear form typically to improve the regression’s
goodness of fit and may reduce simultaneity bias (de Bandt and Davis, 2000).
Molyneux et al. (1996) found that a log linear revenue equation gave similar results as a
more flexible translog equation. The revenue equation in the Panzar-Rosse model is
interpreted as a reduced form rather than a structural equation.
In long-run equilibrium, rates of return should be uncorrelated with input prices. To
test if the banking market is in long-run equilibrium the paper also estimates an
auxiliary equation (2), which tests for the equality of risk-adjusted rates of return
across banks:
 Journal of Economic Studies 2009.36:446-460.

Authors Period Countries considered Results

Shaffer (1982) 1979 New York Monopolistic competition

Nathan and Neave (1989) 1982-1984 Canada 1982: perfect comp.; 1983-1984: monopolistic comp.
Lloyd-Williams et al. (1991) 1986-1988 Japan Monopoly
Molyneux et al. (1994) 1986-1989 France, Germany, Italy, Spain and UK Mon.: Italy; mon. comp.: France, Germany, Spain, UK
Vesala (1995) 1985-1992 Finland Monopolistic competition for all but two years
Molyneux et al. (1996) 1986-1988 Japan Monopoly
Coccorese (1998) 1988-1996 Italy Monopolistic competition
Rime (1999) 1987-1994 Switzerland Monopolistic competition
Hondroyiannis et al. (1999) 1993-1995 Greece Monopolistic competition
Bikker and Groeneveld (2000) 1989-1996 15 EU countries Monopolistic competition
de Bandt and Davis (2000) 1992-1996 France, Germany and Italy Large banks: mon. comp. in all countries; small
banks: mon. comp. in Italy, monopoly in France,
Germany
Bikker and Haaf (2002) 1988-1998 23 OECD countries Monopolistic competition
Hempell (2002) 1993-1998 Germany Monopolistic competition
Coccorese (2004) 1997-1999 Italy Monopolistic competition
Al-Muharrami et al. (2006) 1993-2002 GCC countries Perfect comp.: Kuwait, Saudi Arabia, UAE; mon.
comp.: Bahrain, Qatar; undetermined: Oman
Gunalp and Celik (2006) 1990-2000 Turkey Monopolistic competition
Perera et al. (2006) 1995-2003 South Asian countries Monopolistic competition
Yildirim (2007) 1993-2000 Central and Eastern EC Monopolistic competition
market structure

studies
P-R model results in other
Competition and

Table III.
453
 JES LnðROA þ 1Þ ¼b0 þ ðb1 ln PL þ b2 ln PK þ b3 ln PFÞ þ b4 ln RISKAST
ð2Þ
36,5 þ b5 ln ASSET þ b6 ln BR

where:
454 Ln – natural logarithm;
TREV – total revenue to total assets;
ROA – net profits to total assets;
PL – personnel expenses to employees (unit price of labour);
PK – capital expenses to fixed assets (unit price of capital);
PF – ratio of annual interest expenses to own funds (unit price of funds);
RISKAST – provisions to total assets;
Journal of Economic Studies 2009.36:446-460.

ASSET – bank total assets; and

BR – number of branches of each bank to the total number of branches of
the whole banking system.
To verify that input prices are not correlated with industry returns, the paper regresses
the ratio return on assets (ROA) as the dependent variable. Because ROA can take on
small negative values, following Claessens and Laeven (2004) and Utrero-Gonzalez
(2004), the researcher computes the dependent variable as ln(ROA þ 1) where ROA is
the unadjusted ROA. The long-run equilibrium test measures the sum of the elasticity
of ROA with respect to input prices. If the H-statistic (b1 þ b2 þ b3) ¼ 0, this implies
that the banking market is in long-run equilibrium. If rejected, the market is assumed
not to be in equilibrium. It should be noted that equilibrium does not mean that
competitive conditions are not allowed to change during the sample period. It only
implies that changes in banking are taken as gradual.
Table IV reports in brief the H-statistic values for the different interpretations of the
Rosse-Panzar “H-statistic”.

Values of H Competitive environment test

H#0 Monopoly equilibrium: each bank operates independently as under monopoly profit
maximisation conditions (H is a decreasing function of the perceived demand elasticity)
or perfect cartel
0 , H , 1 Monopolistic competitions free entry equilibrium (H is an increasing function of the
perceived demand elasticity)
H¼1 Perfect competition. Free entry equilibrium with full efficient capacity utilisation
Equilibrium test
H,0 Disequilibrium
H¼0 Equilibrium
Table IV.
Discriminatory power Sources: Rosse and Panzar (1997); Panzar and Rosse (1982, 1987); Shaffer (1982, 1983) ; Nathan and
of H Neave (1989)
 4.3 The data Competition and
In a competitive conditions analysis, production units are expected to be relatively market structure
homogenous, providing similar services and using similar resources. Commercial
banks operating in Saudi Arabia are depository institutions that cannot take part in the
leasing and trading real goods for commercial purposes. In contrast, development and
investment banks can engage in such activities, but they cannot accept deposits. These
non-depository institutions also do not extend small commercial and individual loans, 455
which require a substantial amount of investment in a brick-and-mortar branching
network, work force and red tape, etc. In fact, they are mostly single branch banks that
finance large long-term projects, such as those financed by funds borrowed from the
World Bank, International Monetary Fund or other international organizations, which
provides substantial savings on overhead, monitoring and control costs. Because of
their small market share in the sector as well as quite different technology, structure
and goal, this study excludes development and investment banks and instead
concentrates on commercial banks.
The data are obtained from financial statements of banks, on their web pages on the
internet, annual central bank reports, and from the Fitch-IBCA Ltd Bankscope CD
Journal of Economic Studies 2009.36:446-460.

Rom. This study covers ten banks privately held and domestically owned that are fully
licensed commercial. These are: The National Commercial Bank, Samba Financial
Group, Riyad Bank, The Saudi British Bank, Arab National Bank, Banque Saudi
Fransi, Saudi Hollandi Bank, The Saudi Investment Bank, Al-Jazera Bank and Al-Rajhi
Bank[1]. The period sample covers is from 1993 to 2006. The final sample consists of
panel of 140 bank-year observations. The sample of 140 observations is very similar to
or more than the sample size used in previous studies of banking. For example, Nathan
and Neave (1989) used samples of 39 observations on Canadian trust companies and 33
observations on mortgage companies; Shaffer (1993) used 25 observations on Canadian
banks; and Shaffer and DiSalvo (1994) used samples of 36 and 44 observations on
duopoly banks in alternate specifications.

5. The results
5.1 Market structure
Table V presents the trends of the HHI and CRk for the period 1993-2006 where the
total deposits and total loans have been taken as the measure of bank size. In general,
the CR shows the decreasing trend. CR in deposit market implies a concentrated
market with CR2, CR3 recording 38 and 55 per cent and HHI 1,455 in the 1993. However,
in 2006, CR fell down with CR2, CR3 recording 34 and 46 per cent and HHI 1,226 due to
the decrease of the market share of the bigger banks and the increase of the market
share of the smaller banks. According to the current screening guidelines in the USA,
this market could be described as an “unconcentrated market”. The CR in the loan
market shows similar trend with that in the deposit market.

5.2 Regression results

Although previous studies generally employ ordinary least square estimation
methodology on the cross-section yearly data, this could produce the unstable results.
This paper employs panel regression methodology combining cross-section and time
series data. One of the advantages of having panel data is that it allows controlling for
heterogeneity bias, or the confounding effects of omitted variables that are stable over
 JES
Trends in
36,5 Trends in concentration in deposits concentration in loans
Year CR2 CR3 HHI CR2 CR3

2006 0.34 0.46 1,226 0.35 0.49

2005 0.35 0.48 1,236 0.36 0.50
456 2004 0.36 0.48 1,273 0.37 0.51
2003 0.37 0.50 1,307 0.39 0.52
2002 0.38 0.51 1,298 0.35 0.52
2001 0.39 0.53 1,403 0.39 0.51
2000 0.41 0.55 1,429 0.40 0.50
1999 0.41 0.56 1,420 0.39 0.51
1998 0.38 0.53 1,383 0.45 0.55
1997 0.38 0.53 1,447 0.41 0.60
1996 0.37 0.53 1,424 0.39 0.59
1995 0.38 0.54 1,468 0.40 0.57
Table V. 1994 0.39 0.56 1,466 0.40 0.57
Trends in concentration 1993 0.38 0.55 1,455 0.39 0.57
in deposits and loans
Journal of Economic Studies 2009.36:446-460.

market Source: Calculated by the author from banks annual reports

time. The paper uses the fixed effects estimators, correcting for the effect of any
combination of time-invariant variables that have been omitted, knowingly or not,
from the regression model.
The equilibrium test and the competitive position tests for the pooled data are
reported in Table VI. For both models, this study performed a variety of tests to check
for serial correlation, normality of the residuals and heteroscedasticity and for the
functional form. All tests confirm the good fit of the models. Most of the estimated
coefficients are statistically significant, while there is no evidence of multicollinearity
among the independent variables. All tests confirm the good fit of the models.
The estimated regression equations explained 47 per cent of the variability in the ROA
and 97 per cent in the TREV equation.

Variable LnTREV Ln (1 þ ROA)

Intercept 2 3.543 (23.244) * * * 20.596 (2 5.552) * * *

LnPL 2 0.202 (21.534) 20.053 (2 4.083) * * *
LnPK 0.251 (4.828) * * * 0.016 (3.207) * * *
LnPF 0.180 (8.097) * * * 0.005 (2.457) * * *
LnRISKAST 0.020 (1.061) 20.007 (2 4.015) * * *
LnASSET 1.231 (18.780) * * * 0.048 (7.413) * * *
LnBR 0.348 (3.106) * * * 20.015 (2 1.364)
Adjusted R 2 0.97 0.47
H-value 0.23 0.0
Test result Monopolistic competition Equilibrium
Number of observation 140 140
Table VI. Notes: Significant at *10, * *5 and * * *1 per cent, respectively; the values in parentheses are the
Regression results t-statistics; data covering the period 1993-2006
 In the TREV equation, the coefficients of the unit price of capital, and funds have Competition and
significant positive signs at 1 per cent indicating the direct effect of unit price of market structure
capital, and unit price of fund in the total revenue. The coefficient of the unit price of
labour has an insignificant negative sign suggesting that banks with greater number
of staff may generate lower revenues. The sign of the RISKAST variable is positive
and statistically insignificant; indicating that banks with higher provisions to assets in
their balance sheet may generate higher revenues per Saudi rial of assets. The 457
coefficient of the ASSET variable is positive and statistically significant at 1 per cent.
This suggests that size, in terms of assets, lead to higher total revenue per rial of asset
implying that larger banks seem to be more efficient compared to smaller banks. The
coefficient of the variable depicting size effects in terms of branches, BR, was positive
and statistically significant at 1 per cent; suggesting that banks with greater number of
branches generate higher revenues per branch. This indicates also the Saudi Arabia is
not over branched.
In the TREV equation, in accordance with the actual estimated value of H from the
estimated regression equations, suggest that the H-statistic value is positive and
statistically equal to 0.23 for the period 1993-2006. This result indicates that Saudi
Journal of Economic Studies 2009.36:446-460.

Arabia’s banks earned their revenues in monopolistic competition conditions.

To assess the long-run equilibrium the ROA equation is estimated. The signs of the
regression coefficients of the unit price of capital, labour and funds are statistically
significant and have mixed signs. The signs of the regression coefficients of the unit
price of fund and the unit price of capital are positive and statistically significant at
1 per cent indicating that the higher the fund and the capital, the higher the total
revenue of the banks. The coefficient of the unit price of labour has significant negative
signs at 1 per cent indicating the opposite effect of unit price labour in the total revenue
suggesting that banks with greater number of staff generate lower profit. H-statistic
value is statistically equal to 0 for the period 1993-2006. The above result indicates that
it is in long-run equilibrium.
So this at least implies that bank revenues in those years appear to be earned in
conditions of monopolistic competition. Even though, Al-Muharrami et al. (2006) found
that Saudi Arabia’s bank earn their revenue under perfect competition condition for the
period 1993-2002. The result of the existing paper seems to be more commonsense
during the period 1993-2006. Even though, the Saudi Arabia banking system had
undergone major changes to achieve macroeconomic goals, however, the Saudi Arabia
banking industry is still limited to local banks where international banks are not
allowed to be in Saudi Arabia’s soil with the exception of few branches of other GCC’s
banks. Such an industry would not be best described as a perfect competition industry;
rather, it would be more rational to describe it as a monopolistic competition.

5.3 Implications
Even though, from mid-1975, no new foreign bank entities have been allowed to enter
the Saudi banking system, it does not appear that concentration has increased in the
Saudi Arabia banking industry. In fact, concentration measures reported here indicate
that declines in concentration over the 1993-2006. On the basis of these findings, it is
safe to conclude that Saudi Arabia banking industry is not highly concentrated and the
concentration in general should not cause a big concern since the concentration indices
indicate a decline in concentration over the ten years. However, the results suggest that
 JES SAMA should be very cautious in granting mergers among banks, in particular among
36,5 large “core” banks. Moreover, the results indicate that Saudi Arabia is not over
branched. So, there is a span for more branches within a country. Therefore, Saudi
Arabia Monetary Authority can grant Saudi banks to open more branches within the
country.

458 6. Concluding remarks

This paper investigates the market structure of Saudi Arabia banking industry using
the most frequently applied measures of concentration k-bank concentration ratio
(CRk) and HHI and evaluates the monopoly power of banks during the years of
1993-2006 using the “H-statistic” by Panzar and Rosse. The results show that
Saudi Arabia had moderately concentrated market and moving to less concentrated
position. Both the concentration indices indicate that the country is moving toward a
better position in terms of the market concentration.
The Panzar and Rosse “H-statistic” suggests that banks in Saudi Arabia operate
under monopolistic competition. The estimated value of H-statistic is equivalent to 0.23
during the sample period. The test for the market structure of perfect competition or
Journal of Economic Studies 2009.36:446-460.

monopoly is rejected leading us to conclude that banks earned their revenues in the
condition of monopolistic competition.

Note
1. Al-Rajhi Bank is an Islamic Bank.

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Further reading
Al-Suhaimi, J. (2001), “Consolidation, competition, foreign presence and systematic stability in
the Saudi banking industry”, BIS papers, 4 August.
Capital Intelligence (2006), Bankscope CD Rom Databases.
Journal of Economic Studies 2009.36:446-460.

Corresponding author
Saeed Al-Muharrami can be contacted at: muharami@squ.edu.om

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