Banking Market Structure, Financial Dependence and Growth

This paper explores the empirical relevance of banking market structure on growth. There is substantial evidence of a positive relationship between the level of development of the banking sector of an economy and its long-run output growth. Little is known, however, about the role played by the market structure of the banking sector on the dynamics of capital accumulation. This paper provides evidence that bank concentration promotes the growth of those industrial sectors that are more in need of external finance by facilitating credit access to younger firms. However, we also find evidence of a general depressing effect on growth associated with a concentrated banking industry, which impacts all sectors and all firms indiscriminately. The importance of financial development for economic growth has been extensively analyzed in recent years. The amount of credit that the banking sector makes available for productive uses is one of the most significant measures of financial development. Such an indicator of size of the banking sector has been shown to have a significant, positive effect on growth. In this paper we study whether for a given size, the market structure of the banking sector has empirical relevance for economic growth. If it is agreed that size is important to capital accumulation, does it matter whether the underlying industry structure is unconcentrated, thus approximating perfectly competitive conditions, or whether instead market power is concentrated among few banking institutions? We find that concentration in the banking sector promotes the growth of those industries that are more in need of external finance by facilitating credit access to firms, especially younger ones. However, we also find evidence of a general deadweight loss associated with banking market concentration (i.e., affecting all industrial sectors indiscriminately), which instead depresses growth. We believe there are theoretical reasons, as well as anecdotal evidence, suggesting that the market structure of the banking sector has a non-trivial impact on the process of capital accumulation. Conventional wisdom suggests that any departure from perfect competition in the credit market introduces inefficiencies that would harm firms’ access to credit, thus impacting negatively on growth. Pagano [23], for example, shows this effect in a simple endogenous growth model. On the other hand, some recent contributions have pointed out that banks with monopoly power have a greater incentive to establish lending relationships with their client firms, thus facilitating their access to credit lines. Mayer [20, 21] and Petersen and Rajan [24] highlight this potential incompatibility between bank competition and the establishment of close lending relationships. There is some historical evidence on the positive role of concentrated credit markets