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1 INTRODUCTION
A healthy competition in the financial sector is of utmost importance for several reasons. Like in many other industries, the extent of competition could have implications on efficiency and quality in the provision of financial services, as well as innovation in the financial sector, (Claessens, 2009). This is because when there is adequate competition, banks would seek the best methods of utilizing their resources in such a way that minimizes costs but generates higher profits, in order to stay competitive in the market. Efficiency in the banking industry could ultimately lead to provision of financial services at lower costs. For instance, businesses and households would obtain funds from the banks at lower costs, thus leading to more private sector investment that could stimulate economic growth.
The Lesotho’s banking industry is characterised by few number of banks and high levels of concentration. The high degree of concentration raises fears about the competitive conditions in the industry. Although highly concentrated banking markets raise worries about adequacy of competition, previous studies in banking industries show that banks can still act competitively even in highly concentrated banking industries, (Shaffer, 1993; Baumol et al., 1982). The theory of contestable markets proposed by (Baumol et al., 1982) argues that concentrated markets can still be competitive if there are low barriers of entry and exit. Hence, one cannot conclude about the competitive conditions of the industry by just looking at concentration indices.
This thesis addresses the following questions: firstly, what is the degree and nature of competition in the banking sector in Lesotho? Secondly, how does the competitive conditions of the banking sector in Lesotho compares with other African banking markets?
This study contributes in many ways to the literature on banking sector competition. Although there is a wide research on the topic of measuring the degree of competition in the banking sector, only few studies cover this topic in the context of African banking markets. To be precise, to the best of the researcher’s knowledge, there is no study that analyses the nature and degree of competition in the Lesotho’s banking industry. The findings of this thesis will be of particular importance to policy makers, academics and the consumers of banking services in Lesotho. Knowledge of competitive conditions in the banking sector will assist policy makers to amend and or introduce policies aimed at stimulating competition in Lesotho’s banking industry.
The rest of this thesis is organized as follows: The next section provides a review of the Lesotho’s banking industry. It provides a detailed explanation of how the formal banking industry began, how it changed until now, as well as its relationship with the South African banking industry. Chapter 2 reviews key theoretical and empirical studies that evaluate competition in the financial sector. Chapter 3 outlines the methodology that is used to estimate the degree of competition in Lesotho’s banking industry. Chapter 5 presents analysis of results, while chapter 6 concludes by providing a summary of the thesis and its recommendations.
1.3 The Lesotho Banking Sector
The formal banking in Lesotho dates back to early 1900’s, with the arrival of Standard Bank, a British Bank, which started its operations in 1902 (Maruping 1992). Participation of foreign banks increased when the second foreign bank, Barclays Bank, came to Lesotho in 1957. Barclays Bank focused more on corporate clients than individuals. In 1977, Standard Bank merged with the Chartered Bank to form a new bank, the Standard Chartered Bank. The merger might have hampered competition in one way or the other given the limited number of banks that were operating in Lesotho.
The government of Lesotho established the Lesotho Bank in 1972. This was because the commercial banks were channelling funds from Lesotho to South African markets, thereby financing South Africa’s development projects. Another reason for founding of the Lesotho Bank was that commercial banks were paying customers very low interest rates on their deposits. The authorities initially anticipated the bank to serve as both a commercial bank and a development bank. However, in a short while the bank served purely as a commercial bank. Lesotho Bank operated as commercial bank, although it was envisaged to be a development bank. The bank served mostly businesses owned by Basotho and foreign owned companies operating in Lesotho. In mid-1980’s, Lesotho bank was the largest of the commercial banks operating in Lesotho. The bank provided services to Basotho owned businesses as well as foreign owned businesses operating in Lesotho. During that period, Lesotho Bank was the largest of the commercial banks operating in Lesotho.
Participation of state owned banks increased in 1975 when the government established the Lesotho Agricultural Development Bank (LADB). The bank commenced its operations in 1976. As a result, there were three commercial banks and one development bank in operation in Lesotho. The main reason for the establishment of the LADB was to provide financing for Agriculture. In its first ten years of existence, the LADB extended credit, financed mainly through grants as well as concessional loans from international organizations. The LADB in late 1980s increased its branch network to various areas where the bank did not reach previously. The bank’s increased capacity was however not been fully utilized given that some of the areas that the bank increased its braches to, were less populated. This rapidly increased the bank’s operating costs relative to its income. This challenge, together with increasing defaults by the bank’s customers on loans granted resulted in the LADB being closed in 1998.
The banking market continued to experience major structural changes from mid-1990s to late 1990s. In 1995, a new foreign owned bank, Nedbank Lesotho joined the banking industry. It took over the operations of Standard Chartered Bank. The bank provided services mainly to corporate, business and VIP customers. In a similar year (1995), Standard Bank took over the Barclays Bank. The Lesotho Bank was partially liquidated in 1999 following poor financial performance of the bank. Subsequent to partial liquidation of Lesotho Bank in 1999, Standard Bank purchased a 70 percent share in the bank. These developments reduced the dominance of government-owned banks to private-foreign owned banks.
The Lesotho’s banking system is dominated by foreign-owned banks. As of December 2016, the banking industry consisted of four commercial banks, with 49 branches. Of the four banks, three are subsidiaries of South African banks. The three foreign banks account for about 97 per cent of total banking sector’s assets. The fourth bank (Lesotho Post Bank) is the only domestic bank and is fully owned by the government of Lesotho. Table 1.1 shows the market share of foreign banks compared to that of local-owned banks.
Table 1.1 Banks’ Market Share of Assets by Ownership (%)
2013 2014 2015 2016
Foreign Banks 97.26 97.17 96.81 93.87
Domestic Banks 2.74 2.83 3.19 6.13
Total 100 100 100 100
Table 1.1 depicts market share of foreign vis-a-vi local banks in terms of their total assets. Source: Author’s own computations based on CBL data.
The banks seem to be working towards improving their distribution channels and also implementation of modern technologies so as to increase the reach of financial services that they offer. For example, number of automated teller machines (ATMs) has increased by about 48 per cent from 138 in 2013 to 204 in 2016. In a similar manner, Point of Sale machines increased significantly from 802 in 2013 to 1374 in 2016. This represents an increase of more than 70 percent in three years. The rapid improvement of the distribution channels might be a resultant of a fast growing mobile money services (M-PESA and Eco-cash) that are offered by telecommunications companies in Lesotho. With respect to commercial banks number of branches, there has only been addition of two branches between 2013 and 2016. Table 1.2 shows the commercial banks distribution channels in terms of number of banks, commercial banks branches, ATMs as well as POS machines.

Table 1.2 Commercial Banks Distribution Channels
2013 2014 2015 2016
Number of Banks 4 4 4 4
Number of Branches 45 45 47 49
Number of ATMs 138 159 180 204
Number of POS Machines 802 1050 1168 1374
Source: Central Bank of Lesotho
Close to rsa….move funds to rsa…crdit short…
The banking industry, for the past ten years has remained profitable, and maintained good quality assets. Figure 1.1 depicts measures of commercial banks profitability as measured by return on assets (ROA) and return on equity (ROE) from the year 2006 to 2015. The return on assets ratio measures the ability of banks to generate profit out of assets that they own. On the other hand, the return on equity reveals how effective do banks use their investors’ money. The ROA averaged 2.8 per cent while the average ROE registered an average of 29 per cent from 2006 to 2015. This indicates that banks have been using their assets and their owners’ equity efficiently to generate profit for the past ten years.

Figure 1.1 Commercial Banks’ Profitability

Figure 1.1 shows commercial banks’ profitability ratios, return on assets (ROA) and return on equity (ROE) from 2006 to 2015. Source: Author’s own computations based on CBL data.
Figure 1.2 Non-Performing Loans to Total Assets
Table 1.2 depicts the banking industry ratio of non-performing loans to total asset. Author’s own computations based on CBL data.

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