Assessing Market Competition in the Chinese Banking Industry Based on a Conjectural Variation Model

Abstract Most literature on market competition in the banking industry neglects to address strategic interaction among banks. This paper studies interaction among Chinese banks by dividing banks into two groups: dominant banks (the “Big 5” state‐owned banks) and small‐ and medium‐sized banks (joint‐stock banks and large city commercial banks). We test an oligopolistic model with conjectural variation developed by Spiller and Favaro (1984). Using data from 2007 to 2016, we find that banking competition is not in the form of Stackelberg competition per se. Some strategic interactions exist between small‐ and medium‐sized banks and the largest state‐owned bank. We also study the effect of interest rate deregulation on oligopolies' strategic interactions. Our results show that interest rate deregulation stimulates banking competition by reducing collusiveness among the dominant state‐owned banks and enhancing the market power of small and medium banks.