Contestability, Technology and Banking

Abstract

Information technology affects banking in two main ways. First, it may reduce costs by replacing paper-based, labour intensive methods with automated processes. Second, it may modify the ways in which consumers have access to banks' services and products and, hence, may enhance the contestability of markets, especially in retail banking. In this paper, we focus on the second aspect. We measure the degree of competition using retail interest margins for a number of different bank products and analyse the effect of technology within a simple model of contestability. Based on the model, we argue that technology has reduced sunk costs for deposits more than for loans. We test this conjecture by estimating the model using semi-aggregated data for a panel of 10 of the 12 euro area countries. Hence, we utilise time series and cross-sectional variation in the use of technology, which circumvents some of the problems in the measurement of sunk costs encountered in the previous literature. We find strong support for an increase in contestability in time deposit markets, and effects that are more moderate for loan markets. These results appear to be robust across a variety of econometric specifications.

Keywords: Banking structure, Contestability, Technology, Internet