Creating contestable banking market: The effect of changes in the regulatory structure in Indonesia

Abstract

Banks have market power due to the existence of product differentiation, high switching costs, locational characteristics, banks specialised knowledge and segmented customers. Therefore, creating a contestable market is more realistic than establishing perfect competition. This study aims to examine the role of opening the market to create contestability. In the last 30 years, the industry experienced structural changes from a closed-regulated into open-less regulated industry. The Panzar-Rosse method is employed to estimate the degree of competition, find the market structure and assess the impact of opening the market to competition. This study found that in a free entry market, banks are more competitive. The potential entrants act as market discipline so it facilitates the creation of a contestable market as observed in 1989. On the other hand, the absence of potential entrants explains the lack of market discipline for the incumbents to operate efficiently in the 2000s.