The internal structure of the domestic banking industry under international competition: Evidence from Colombia

This analysis presents a simultaneous equation approach to describe the relationship between liberalization and competitiveness in the Colombian financial system. The findings support the hypothesis that banks increase asset risk during periods of market liberalization. There is no evidence of market discipline, or depositors' response to changes in bank's fundamentals, for the Colombian case. The findings are consistent with other studies of risk and liberalization according to the hypothesis that bank risk increases significantly during periods of financial liberalization only if depositors fail to discipline banks. The results also suggest that depositors are stricter with foreign banks than local banks. This change in depositor's behavior explains, in part, the different strategies that local and foreign banks have for managing the average loan portfolio risk.; Using the production approach to measure banking output, this analysis utilizes a trans-log function to estimate banking output in Colombia. The entire sample of banks operating in the Colombian financial system was divided into two groups according to their relative market share. The results show evidence of significant scope economies for large banks and small banks. There are almost constant returns to scale for large banks, some scale economies for small banks, and overall constant returns to scale for the entire sample. The findings differ from previous studies conducted in other developing countries that show evidence of scale and scope economies in the banking sector under this specific approach.; This analysis also presents a simultaneous equation approach to measure the link between regulation, capitalization and inefficiencies. The findings support the hypothesis that managers will engage in inefficient behavior by investing in riskier assets when the actual observed asset quality declines. Also, the post estimation results show evidence supporting the a priori hypothesis that local and foreign banks adopt different strategies with respect to loan portfolio risk as a reaction to changes in the regulatory framework and the minimum capital requirements. Evidence about the positive effects that the adoption of international standards on capitalization could have on the entire financial system is inconclusive for the Colombian case under this specific approach.