entrants may be as important in influencing the behavior of banks as the number of actual competito.s in the market. For example, the Canadian banking system is highly concentrated and dominated by six large banks. Yet, studies of Canadhin banking have found it to be highly competitive4 . It is also notable that in Canada, thne Netherlands and Sweden, where concentration is quite high by international standards, banks operate with lower spreads and earn higher profits than in Italy, Norway and the United States, where banking contzitration is low<sup>5</sup> .

With regard to the role of public sector banks, the experience of state-owned banks in France and Austria and of the savings and cantonal banks in Germany and Switzerland suggests that state ownership of banking institutions is not necessarily incompatible with high operational efficiency. What seems to be required for efficiency is that state-owned or state-controlled banks operate in a competitive environment, enjoy managerial autonomy and independence from political intervention, and are accountable to a nonpolitical supervisory authority.

In Hungary, it is the combination of a high level of market concentration with the dominant role played by state-controlled institutions that implies that competitive forces may not be as strong and responsive to changing market conditions as might be desired. This situation is not uncommon in developing countries. The banking systems of many countries from Argentina to Egypt, Pakistan, Sri lanka and Tunisia exhibit similar structural features.

To strengthen the impact of competitive forces, it is necessary to increase the threat of potential competition by opening market entry not only to joint venture banks but also to whollyowned subsidiaries or branches of foreign banks, while to help large domestic banks respond to the challenge of foreign competition it is necessary to accelerate the commercialization, restructuring and eventual privatization of most, if not all, state-owned institutions.

Developing countries have traditionally expressed concern about the role and impact of foreign banks. This concern reflects two, sometimes contrary, fears. First, there is concern that foreign banks may acquire dominant positions in domestic markets and drive out of business local institutions that are less efficient and have fewer capital and managerial resources. The second criticism is that foreign banks engage in 'cream skimming" by dealing in profitable segments of the market and capturing economic rents resulting from existing regulations or the inefficiency of domestic banks.

These concerns were probably justified during colonial times when foreign banks behaved like colonial institutions and exploited local markets. But experience over the past two decades or so suggests that the first concern is not justified, because foreign banks are unlikely to acquire dominant positions in domestic banking systems, both because they are sensitive to local political concerns and because they may be deterred by the high capital and information costs of building a strong presence in retail markets.

4 For empirical **tests** of competition and market concentration, see Nathan and Neave (1989) and Shaffer (1990).

_5_ For a discussion of differences in operating costs and efficiency among some developed countries, see Vittas (1991).

**4**