Banking Sector Ripe for Consolidation

With no less than 25 competing groups, Jordan’s banking sector could benefit greatly from a little consolidation.

By Jawad J. Abbassi

Bank consolidation

A common measure for market concentration is the Herfindahl–Hirschman Index, or HHI. It’s defined as the sum of the squares of the market shares of the firms within a sector. The HHI number can range from close to zero to 10,000. The closer a market is to being a monopoly, the higher the market’s concentration (and the lower its competition). If, for example, there were only one firm in a given industry, then that firm would have a 100 percent market share, and the HHI would be 10,000, indicating a monopoly. If there were thousands of firms competing, each would have nearly a 0 percent market share, and the HHI would be close to zero, indicating nearly perfect competition.

Calculating the HHI index for Jordan’s banking sector, with its 25 groups, reveals the market isn’t concentrated and has ample competition. In 2014, banks’ assets totaled JD43 billion and the HHI measure for assets was 911. Credit faculties totaled JD19.2 billion and the HHI index was 795. Deposits totaled JD31.4 billion with the HHI index measuring 926.

Whereas the top three banks have over 40 percent in assets, credit facilities, and deposits, Jordan’s banking sector is also characterized by the presence of many smaller scale banks. The smallest 10 banks’ share of total assets, deposits, and credit facilities was less than 10 percent of total market size in 2014. This suggests that the market can accommodate consolidation amongst the smaller banks without negatively affecting its market concentration index. If the smallest five banks merged, the HHI index in assets would only rise by 16 points, by 7 points for credit facilities, and by 11 points for deposits. While if the top three banks merged, the HHI index would rise by over 1,000 points making the market highly concentrated.

For a long time, consolidation has been a Central Bank declared policy. Yet very little consolidation happened in the market due to what observers call “family entrenchments.” Basically, smaller banks dominated by owner-managers have no interest in diluting controlling stakes that would result from mergers.

The Central Bank can encourage more consolidation in the market by opening the door to more licenses for Jordanian banks. The de-facto freeze on new banks licenses in Jordan negatively affects the objective of encouraging consolidation amongst smaller banks by making existing licenses seem “valuable” in their own right. Basically, as no one can enter the market, the current market players view their current licenses as scarce, and hence more valuable.

With central banks across the world aiming to have no one bank as “too-big-to-fail,” allowing new bank licenses in Jordan could be the road towards consolidation amongst smaller banks and even lower market concentration in the industry. The “optimal” number of banks in the country should be left to market forces rather than by the current de-facto ban on new licenses. In return for issuing new licenses, the government can charge relatively high licensing fees with conditions that require high initial capitals for any new bank.

Finally, the potential for new innovative models in banking would rise with the opening up of the market. Jordan could, for example, end up with branch-less Internet banks that are able to pay higher yields on deposits and more competitive rates on credit facilities since their cost structure would be much lower than traditional banks with extensive branch and ATM networks. These can attract more deposits from Jordanians abroad and avail cheaper credit to businesses in Jordan’s economy.