Market Power in Discrete-Choice Demand Functions of Banking Services - An Application to Spanish Banks

Abstract

This paper analyzes the evolution of price and non-price competition in the Spanish banking market during the period 1983-2003. Banks produce three outputs and the demand for each of them is modelled as a discrete-choice decision made by buyers. The decision variables of banks are, on the one hand, the interest rates, advertising expenditures and services (number of branches) that determine the consumer valuation of the bank's output and, on the other hand, the number of workers and IT capital, that are the variable inputs used in production. We model the profit maximizing behaviour of the representative bank and jointly estimate the parameters of the demand and supply functions under the profit-maximizing restrictions with data from Spanish banks. We compare the competitive conditions in the banking industry in the first and the second part of the time period and we simulate the predicted equilibrium values of demand, supply, prices and profits under changes of the interbank interest rate and the opportunity cost of capital.