Recent turmoil in the global financial system has impacted severely on the banking sector with many banks suffering large losses and necessitating the need to raise additional capital privately or through their respective national governments. In our study we investigate the impact of structural reforms performed throughout the European Union (EU) accession process on competition and contestability of banking systems in Romania.

The literature of the measurement of competition can be divided into two major approaches: structural and non-structural. The structural approach to the assessment of competition embraces the „Structure-Conduct-Performance Hypothesis” (SCP) and the „Efficient Structure Hypothesis” (ESH). The structural approach, as the name suggests, assesses bank competition by examining measures of market structure such as concentration ratios (the share of assets held by the top 3 or 5 institutions) or indices (e.g., the Herfindhal-Hirschman index) and supposes that higher concentration in the banking market causes less competitive bank conduct and leads to higher bank profitability. The SCP model is originally developed by Bain (1956). The second approach, ESH, developed by Demsetz (1973) and Peltzmann (1977) suggests that the superior performance of the market leaders determines the market structure, implying that higher efficiency produces both higher concentration and greater profitability. The non-structural indicators of competition are mainly based on the measures of monopoly power developed by Lerner (1934). The Lerner Index suggests the mark-up of price over marginal cost. An alternative non-structural indicator of the degree of market competition is the Panzar and Rosse (1987) H-statistic. The H-statistic measures the extent to which changes in banking costs are reflected in changes in banking revenues.

In order to examine the level of competition and market power of banks in Romania for period 2003 – 2009, we estimate the non-structural indicators and compare it with the structural indicators of competition.

In particular, we measure competition using Lerner index and the H-statistic, indicators what are estimated using bank-level data and are compared with a standard market structure measure of concentration like HHI and CR5. There are no other studies that measure both structural and non-structural competition indicators for Romanian banking sector. Also, our assessment contains a period of seven years including the begging of the implications of the present international financial crises on Romanian banking sector.

The structural indicators show continuous increase of competition in the Romanian banking system. Lerner index and H statistic demonstrate that Romanian banking system is characterized by monopolistic competition and relatively competitive practices. Personnel cost, operational cost and financial cost are statistically significant at conventional levels, which imply good fit of the revenue equations. The results also demonstrate that excess fixed assets do not generate abnormal revenue.