Profits and "contestability" in highly concentrated banking markets

Abstract

It has been suggested that monopolistically structured banking markets will perform competitively because banks have so many potential competitors and these markets are contestable. This hypothesis is tested on 2,861 banks in 1,286 markets. The tests compare rates of return of banks in markets with one, two, three and four banks with similar sized banks in metropolitan markets. The findings clearly reveal that rates of return in markets with few banks are significantly higher than those in markets with many competitors. These results question the validity of the theory of contestable markets in banking.