[Seungseop Song's Financial Light] Banks and Oligopoly Markets

The 'Oligopoly Structure' of Banks Criticized by the President
Domestic Banks Formed an Oligopoly Market Due to the Foreign Exchange Crisis
Government and Financial Authorities Seek Measures to 'Break the Oligopoly'

Editor's NoteFinance is difficult. Confusing terms and complex backstories are all tangled together. Sometimes, you need to learn dozens of concepts just to understand a single word. Yet finance is important. To understand the philosophy of fund management and consistently follow the flow of money, basic financial knowledge must be in place. Therefore, Asia Economy selects one financial issue each week and explains it in very simple terms. Even if you know nothing about finance, you can immediately understand these 'light' stories that turn on the bright 'light' of finance for you.

Domestic banks are earning high profits thanks to elevated benchmark interest rates and are being criticized for holding bonus parties. Even the president has raised concerns. President Yoon Suk-yeol pointed to the oligopolistic structure of banks as the fundamental cause. Let's examine what harms an oligopolistic market creates and whether the current problems in the financial sector are truly due to oligopoly.

Oligopolistic Markets Reduce Consumer Welfare

An 'oligopoly market' refers to a market dominated by a small number of firms. In economics, the characteristic of an oligopoly market is described as "producing less output and charging higher prices than a competitive market." Normally, companies continuously invest and innovate to increase profits. In this process, production increases and prices decrease. However, in an oligopoly market, since no new competitors emerge, innovation is unnecessary. Production is less than the market's required level, and prices are high.

There are various reasons why oligopoly occurs. First is the 'entry barrier.' If it is difficult for new competitors to enter the industry from the start, an oligopoly market forms. This could be cases where government approval is required to operate, massive initial capital is needed, or very difficult technology is necessary. Oligopoly can also form as a result of fierce competition. Initially, many companies compete, but inefficient firms are eliminated, and a few innovative firms establish an oligopoly market.

Oligopoly markets can also form through anti-market methods. Sometimes companies use methods on the borderline between legal and illegal to drive out competitors. Instead of gaining market dominance through quality improvement and price innovation, if some companies unite purely to monopolize the market, an oligopoly market is created.

Oligopoly markets reduce consumer welfare. Since there are only a few firms in the market, they do not compete by lowering prices. Instead, they engage in 'non-price competition.' This includes product differentiation, advertising, and various sales conditions. There is also a tendency to collude on prices or act like a single monopoly through corporate alliances (cartels) or trusts without competition. Because the number of firms is small, the actions of one firm strongly influence others. If one firm raises prices, others follow suit.

Domestic Banks Enjoying Oligopoly Benefits Since the Foreign Exchange Crisis

Types of Markets According to the Number of Producers. Source=KDI

At first glance, it might seem that oligopoly markets should be eliminated at all costs, but in reality, they are the most common market structure. Telecommunications, movie theaters, department stores, airlines, home appliances, automobiles, alcohol, and ramen are examples of oligopoly markets. On the other hand, the perfectly competitive market, considered ideal in economics, is rarely seen in reality. If the government intervenes to eliminate all oligopoly markets, various side effects may occur. Therefore, experts say that for oligopoly markets, strict monitoring of 'unfair practices' is necessary rather than elimination. They emphasize thorough surveillance to ensure no collusion or unfair acts to eliminate competitors.

So, is the banking market an oligopoly? Looking at the domestic Banking Act and the formation process of the five major banks (KB Kookmin, Shinhan, Woori, Hana, NH Nonghyup), it clearly appears to be an oligopoly market. First, to operate a bank in Korea, government approval is mandatory. Also, regulations to operate are extremely stringent. This means it is difficult for new competitors to emerge.

Moreover, these five banks did not become oligopoly players through bold innovation. They were able to grow in size during the restructuring process after the 1990s IMF crisis. In fact, they became an oligopoly market thanks to the government. According to a 2005 report by the Bank of Korea's Financial Economic Research Institute, "Korea's banking industry has been reorganized around a few large banks," and "this structural change largely stems from the government's injection of public funds into banks after the foreign exchange crisis, which were then sold to the private sector on the premise of mergers."

Simply put, the government saved banks that collapsed due to the foreign exchange crisis with taxpayers' money, and during the process of transferring them back to the private sector, some banks significantly increased their size. In 1997, there were 26 commercial banks in Korea. It was not an oligopoly market. However, due to the foreign exchange crisis, the government carried out restructuring, reducing the number of banks, including regional banks, to 12.

How about the market dominance of the five major banks? According to financial authorities, last year the five major commercial banks accounted for 71.4% of the loan market, which is high. They also held 63.4% of the deposit market. However, there is a counterargument that the top three banks by asset size according to the World Bank rank around 18th globally, which is not very high.

Government Seeking Ways to Ease Oligopoly Market

Kim So-young, Vice Chairman of the Financial Services Commission, is delivering opening remarks at the '1st Task Force on Improvement of Banking Sector Management, Business Practices, and Systems' held at the Government Seoul Office Building on the 22nd of last month. Photo by Yoon Dong-joo doso7@

Due to this oligopolistic system, the government believes that current banks do not seek new revenue sources and focus only on easy businesses like interest margin operations. The interest income proportion of the five major banks' total operating profit exceeds 90% on average. In contrast, JP Morgan or Bank of America are around 50%. The net interest margin is also the highest among major advanced financial countries except for the US and UK. This means they have earned domestic-focused profits by gathering funds through stable deposits and bond issuance and lending through loan businesses.

The government has started efforts to ease the oligopolistic structure of the banking sector. It has formed a 'Banking Sector Management, Business Practices, and Institutional Improvement Task Force' and begun exploring measures. Financial Supervisory Service Governor Lee Bok-hyun also instructed executives in a meeting to find ways to break the oligopoly form of the five major banks. Industry alternatives being discussed include expanding the role of internet-only banks, fintech financial sector entry, transforming savings banks into commercial banks, and issuing 'small licenses' by splitting permits.