How Does Competition Affect Efficiency and Soundness in Banking? New Empirical Evidence

46 Pages Posted: 5 Nov 2008

See all articles by Klaus Schaeck

Klaus Schaeck

University of Bristol

Martin Čihák

International Monetary Fund (IMF)

Multiple version iconThere are 3 versions of this paper

Date Written: September 30, 2008

Abstract

A growing body of literature indicates that competition increases bank soundness. Applying an industrial organization based approach to large data sets for European and U.S. banks, we offer new empirical evidence that efficiency plays a key role in the transmission from competition to soundness. We use a two-pronged approach. First, we employ Granger causality tests to establish the link between competition and measures of profit efficiency in banking, and find that competition indeed increases bank efficiency. Second, building on these results, we examine the relation between the Boone indicator [Boone, J. (2001) Intensity of competition and the incentive to innovate. IJIO, Vol. 19, pp. 705-726], an innovative measure of competition that focuses on the impact of competition on performance of efficient banks, and relate this measure to bank soundness. We find evidence that competition robustly increases bank soundness, via the efficiency channel.

Keywords: bank competition, efficiency, soundness, market structure, regulation

JEL Classification: G21, G28, L11

Suggested Citation

Schaeck, Klaus and Cihak, Martin, How Does Competition Affect Efficiency and Soundness in Banking? New Empirical Evidence (September 30, 2008). ECB Working Paper No. 932. Available at SSRN: https://ssrn.com/abstract=1240856

Klaus Schaeck (Contact Author)

University of Bristol ( email )

University of Bristol,
Senate House, Tyndall Avenue
Bristol, BS8 ITH
United Kingdom

Martin Cihak

International Monetary Fund (IMF) ( email )

700 19th Street N.W.
Washington, DC 20431
United States

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