An analysis of competition, efficiency and soundness in the South African banking sector

Background: The banking sector plays an important role in economic activity: it mobilises savings and channels them to productive sectors thus encouraging the efficient allocation of resources. The competitive nature of the environment under which the banking sector operates is of paramount importance. Aim: The main aim of this study was to investigate the relationship between competition, efficiency and soundness in the South African banking sector. Setting: The setting for this study was the South African banking sector. Methods: We used a data set of 17 local and international banks for the period 2004-2015 and stochastic frontier models to analyse efficiency. Results: Results show that the impact of competition on efficiency depended on the measure of competition used. When using the Lerner index there was a negative effect of competition on efficiency while the opposite was true when using the theoretically robust Boone indicator. Conclusion: In the case of bank soundness, competition using the Boone indicator is negatively related to the Z score, implying that competition enhances bank soundness and these results supported the prudent and efficient management hypothesis.