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What is the effect of banking Effect of

banking on
concentration and competition financial
development
on financial development?
An international assessment
Claudio Oliveira De Moraes Received 30 March 2020
Revised 4 September 2020
Central Bank of Brazil, Rio de Janeiro, Brazil and 21 September 2020
Coppead - Graduate Business School, Rio de Janeiro, Brazil Accepted 22 September 2020

Jos
e Americo Pereira Antunes

Central Bank of Brazil, Rio de Janeiro, Brazil, and
M
arcio Silva Coutinho
Caixa Economica Federal, Rio de Janeiro, Brazil

Abstract
Purpose – This paper analyzes the effect of the banking market (concentration and competition) on financial
development.
Design/methodology/approach – In order to estimate the effects of banking concentration and competition
on financial development, we conducted an empirical analysis using the System Generalized Method of
Moments (S-GMM) through a dynamic panel data model.
Findings – The main results suggest that concentration and competition affect financial development. In
particular, an increase in bank concentration may inhibit the country’s financial development, due to the lack of
competition. Our results do not confirm the controversy between concentration and competition, suggesting
that concerning financial development, concentration is the reverse of competition.
Practical implications – The results of this study add a new perspective on banking market power: a
financial system concentrated or uncompetitive constrains financial development.
Originality/value – The literature that combines the investigation of the effects of banking market structure
(concentration) and banking market conduct (competition) on financial development is scarce. Although a
concentrated banking sector can reduce competition through barriers to new entrants (which could expand
financial services offer), it is also true that a concentrated banking sector can be competitive. In order to avoid
the controversy, our paper chooses to look into a comprehensive approach considering independent measures
of bank concentration and bank competition, which together refer to the banking framework.
Keywords Financial development, Banking concentration, Banking competition
Paper type Research paper

1. Introduction
There is strong evidence supporting that financial sector development plays a significant role
in economic development. An efficient financial system favors resource allocation, as well as
reduces costs derived from acquisition and processing of information, hence providing better
and low cost services to creditors and borrowers (Claessens and Laeven, 2004). Therefore,
investigating frictions that restrict financial development and the social welfare it represents
is central to subsidize policy makers to better address financial system efficiency. A relevant
issue on this subject is the banking market structure. In particular, the effect of financial
systems’ concentration (De Nicolo et al., 2004) and competition (Amidu and Wolfe, 2013) on
financial development.
The works that investigate the relevance of financial development since Beck et al.
(2000) and Levine (2003) find a positive relationship between financial development and Journal of Economic Studies
economic growth. Recently, studies involving financial development (Adu et al., 2013; © Emerald Publishing Limited
0144-3585
Herwartz and Walle, 2014; Beck et al., 2014; Khoutem et al., 2014; Law and Singh, 2014; DOI 10.1108/JES-03-2020-0140
JES Durusu-Ciftci et al., 2016; and Azofra et al., 2018) and income inequality (Seven and Coskun,
2016) were embodied to the literature. At present, a new branch of the literature studies the
different aspects of financial development (Sahay et al., 2015). The financial development
index proposed by Svirydzenka (2016) aggregates financial institutions and financial
markets measures and allows one to analyze the effect of banking market structure on
financial development under a financial intermediation perspective.
Following Love and Mart
ınez Per
ıa (2015), the structure-conduct-performance paradigm
(SCP) assumes a causal relationship among the structure, conduct and performance of the
banking industry (Memanova and Mylonidis, 2020). Under this perspective, fewer and larger
firms, thus a more concentrated banking system, present market power issues and are more
likely to engage in anticompetitive behavior. According to Degryse and Ongena (2009), the
literature on banking market structure shifted from SCP to New Empirical Industrial
Organization (NEIO). Based on NEIO, two additional branches of literature evolved. The first
one defines competition as endogenous to the market structure, which means that more efficient
banks increase their market share, hence concentrating it. The second one seeks to measure
competition from non-price dimensions of bank products, such as the availability of credit and
bank-firm relationships. NEIO approaches are grounded on financial intermediation theories.
This study blends these two streams of research. From SCP, we borrow the concentration
measures used as proxies for market power. From NEIO, we borrow the competition
measures (Lerner and Boone indices) and the financial intermediation theory, which
underpins the financial development index developed by Svirydzenka (2016). Combining
these perspectives, allows one to posit the following research question: What is the effect of
banking concentration and competition on financial development? To investigate the role of
concentration and competition on countries’ financial development, we used a dynamic panel
of 89 countries–28 developed and 61 emerging–with annual data over the period 2006–2015.
Our results suggest that concentration and competition affect the level of countries’ financial
development. In particular, an increase (decrease) in bank concentration (competition) leads
to a reduction in financial development. Moreover, we identify that an improvement in the
banking market structure (a decrease in concentration or an increase in competition) is also
relevant for the financial development of emerging economies.
The literature that simultaneously investigates the effects of concentration and
competition on financial development is scarce. Concerning the effects of banking market
structure on financial stability, the literature is ambiguous. From the competition-fragility
view, as Kasman and Kasman (2015) point out, decreases in market power and profit margins,
encouraging additional risk-taking, pose a threat to financial stability. Conversely, the
competition-stability view holds that less banking market power drives the cost of credit
down, reducing loan default rates, which benefits financial stability (Fung
acov
a et al., 2017).
As for the effects of concentration on financial stability, Fu et al. (2014) argue that greater
concentration fosters financial fragility, considering cross-country data from Asia Pacific
countries. On the one hand, Ben Ali et al. (2015) argue that concentration has a positive impact
on financial stability through the profitability channel. Azmi et al. (2019) assert that
concentration is beneficial for banking stability in economies where Islamic and conventional
banks coexist. Regarding the effects of banking competition, Amidu and Wolfe (2013) assert
that competition enhances financial stability in developing countries, as long as income
generating activities increase, for it is identified as a channel through which competition
affects banking insolvency risk. Consistent with this argument, Beck (2008) suggests that
competition is not detrimental to banking system stability in a market-based financial system
with the necessary supporting institutional framework and proper policies.
The controversy between concentration and competition can also be present in the way
banks provide financial services. Cetorelli and Gambera (2002) find evidence that banking
concentration supports the growth of industrial sectors that need external financing, making
it easier for young companies to access credit. Chauvet and Jacolin (2017) present a positive Effect of
impact of financial inclusion on firm growth when the banking market is more competitive, banking on
suggesting that financial inclusion and banking competition may complement each other.
The results also suggest that greater banking competitiveness has a positive impact on firm
financial
growth only in countries where firms have a high level of financial inclusion. Moreover, Bara development
et al. (2017) find that a reduction in banking concentration, as well as an increase in
competition, stimulates economic growth.
Although a concentrated banking sector can reduce competition through barriers to new
entrants (which could expand financial services offer), it is also true that a concentrated
banking sector can be competitive (Vives, 2016). In order to avoid the controversy, our paper
chooses to look into a comprehensive approach considering independent measures of bank
concentration (Bank_5 and Bank_3 indices) and bank competition (Lerner and Boone
indices). In order to capture the degree of the financial services provided, we use the financial
development index developed by Sahay et al. (2015) and Svirydzenka (2016), which reflects
three dimensions of financial intermediation: depth, access, and efficiency.
The article is organized as follows. In Section 2, we present the data and discuss the
empirical methodology. Section 3 presents our main results and Section 4, the robustness
checks. Section 5 concludes.

2. Data and methodology

The present work makes use of annual data from 2006 to 2015. The decision about the period
of analysis concerns data availability for a higher number of countries. For that reason we
built an original database for 89 countries. The sample used to investigate the effect of
banking concentration and competition on financial development consists of 28 developed
countries and 61 developing countries. All data were extracted from the International
Monetary Fund and World Bank websites [1].
In general, the financial development of countries can be analyzed through two approaches,
according to the source of financing: capital markets and financial intermediation as provided
by banks. The financial development measure developed by Sahay et al. (2015) and
Svirydzenka (2016) allows one to analyze these two approaches separately. In this sense,
Financial Institutions Index (FI) reflects three dimensions of financial intermediation: depth,
access, and efficiency. Depth means the size of markets; access is the ability of financial
institutions to offer individuals and companies access to financial services; efficiency is the
capacity of institutions to provide financial services at low cost and sustainable revenues.
According to Seven and Coskun (2016), financial development presents complex
institutional and political dimensions. Therefore, the influence of banking concentration,
as well as competition, on financial development can be different depending on country
characteristics. This reasoning provides the motivation for a second analysis, which
highlights the effects of the banking market structure, hence concentration and competition,
on the financial development of developing countries. Accordingly, the average financial
development (FI) in developed countries is higher than in developing ones, as the descriptive
statistics across the samples shown in Table 1 reveal.
As stated by Berger et al. (2004), the consolidation of banks around the world intensified
the debate about the effects of concentration and competition on banks’ performance.
Following this argument, this study used two variations of the largest banks’ total assets as
measures of banking concentration. Following Kasman and Kasman (2015), the first measure
aggregates the assets of the five largest banks (Bank_5), while the second measure, derived
from Fu et al. (2014), aggregates the assets of the three largest banks (Bank_3). Both measures
are scaled by the total assets of commercial banks.
Regarding competition measures, this study resorts to measures often used in the
literature. Therefore, in our study, we used the Lerner and Boone indexes, which are available
JES for the entire period considered. The Lerner index is a measure of market power (Demirg€ uç-
Kunt and Martinez Per
ıa, 2010). Thus, the higher the market power, the lower the competition.
The Boone index measures the degree of banking competition from the elasticity of profits to
marginal costs, as Kasman and Kasman (2015) point out. The reasoning that underpins the
indicators is that more efficient banks achieve the highest profits. Therefore, an increase in
the Boone and Lerner indexes reflects a hindrance to financial intermediaries’ competition.
In order to control the effect of banking concentration and competition on financial
development provided by banks, we used banking and macroeconomic variables. For that,
we followed Kasman and Kasman (2015) and used the ratio of non-performing loans (NPLs) to
capture the relation between credit risk and financial development. The capital adequacy
ratio (CAR) is used to capture the trade-off between financial stability and financial
development. CAR is an international standard that measures a bank’s risk of insolvency
from excessive losses and equals the regulatory equity divided by the risk-weighted assets
(De Moraes et al., 2016). From financial development literature, the following macroeconomic
variables are used: real interest rate (INTR), Bara et al. (2017) use this variable as control in a
model whose dependent variable is financial development; annual GDP growth rate (GDP)
based on constant local currency (Raza et al., 2014) and, concordantly with Chinn and Ito
(2006) the inflation rate (INFL). Following De Moraes and De Mendonça (2019), the effect of
the subprime crisis on financial development is captured through the dummy CRISIS, which
assumes value 1 for the years 2008 and 2009 and 0 elsewhere. Descriptive statistics of the
variables used are reported in Table 2.
The use of the dynamic panel, in which the lagged dependent variable functions as an
explanatory variable, allows us to analyze the effect of concentration and competition on
financial development, controlled by the persistence effect (De Mendonça and De Moraes,
2018). This is possible because the lagged financial development explains a relevant portion
of financial development variation. Therefore, the current degree of financial development is
expected to be affected by past financial development as well as lagged banking variables
(NPL and CAR) and lagged macroeconomic variables (INTR, GDP, and INFL). Moreover,
following Berger et al. (2004), and Jayakumar et al. (2018), we used country-level analyses for
banking concentration and competition. Hence, we estimate the following specification:
Financial developmenti;t ¼ β0 þ Financial developmenti;t−1
þ Banking market structurei;t−1 þ Controlsi;t−1 þ Crisisi;t
þ εi;t
(1)

where i ¼ 1; 2; 3; . . . ; 89 are the countries and t ¼ 1; 2; 3; . . . ; 9 is the period in years;

Financial Development is the financial development index (FI); Banking Market Structure is
the set of interest variables associated with banking concentration (Bank_5 and Bank_3) and
banking competition (Lerner and Boone indexes); Controls is the set of lagged banking and

All Developed Developing

Mean 0.527 0.745 0.427

Median 0.508 0.767 0.434
Maximum 0.995 0.995 0.743
Table 1. Minimum 0.127 0.484 0.127
Financial development Std. dev. 0.210 0.143 0.152
across samples Countries 89 28 61
 Standard
Effect of
Observations Mean Median Maximum Minimum deviation banking on
financial
Financial development
FI 890 0.527 0.508 0.995 0.127 0.210 development
Banking Market Structure
Bank Concentration 875 78.525 79.230 100.000 28.800 14.418
(BANK_5)
Bank Concentration 887 63.086 62.490 100.000 20.480 15.958
(BANK_3)
Bank Competition 781 0.281 0.270 0.940 0.630 0.150
(LERNER Index)
Bank Competition 884 0.075 0.040 1.130 3.200 0.227
(BOONE Index)
Control variables
NPL 830 6.129 3.720 47.750 0.200 6.565
CAR 837 16.445 15.800 43.400 1.750 4.647
INTR 852 5.630 4.898 54.680 42.310 7.687
INFL 883 5.193 3.745 109.681 35.837 6.875
GDP 889 3.595 3.617 34.500 20.493 4.246 Table 2.
Note(s): Control variables: bank nonperforming loans to total loans (NPL); bank regulatory capital to risk- Summary statistics (all
weighted assets (CAR); real interest rate (INTR); inflation index (INFL); growth rate (GDP) countries)

macroeconomic control variables: NPL, CAR, INTR, GDP and INFL; Crisis is the dummy
variable to capture the subprime crisis and ε is the residual of the estimation.
Despite the advantage of using dynamic panel models, the lagged dependent variable’s
use can generate bias and inconsistency in the estimates due to the possible correlation
between the explanatory variables and the error. The Generalized Moments Methods (GMM)
can deal with lagged dependent variables, as Arellano and Bond (1991) suggested. In
particular, we run our estimations through the System Generalized Method of Moments
(S-GMM), which combines regression equations in differences and levels in a system, and
uses the lagged variables in difference and level as instruments (Arellano and Bover, 1995).
To avoid an excess of instruments in the regressions, which could harm the test’s statistical
power, the amount of instruments used in the study is smaller than the number of cross-
sections [2]. To confirm the validity of the estimations reported, the test of over-identifying
restrictions (J-test) is performed (Arellano, 2003). In addition, the first and second order serial
auto-correlation tests (AR1 and AR2) are also performed.

3. Empirical analysis
In this section, we analyze the effects of banking market structure on financial development.
In particular, the analysis of the effect of banking concentration on financial development is
presented on Tables 3 and 4, whereas the analysis of banking competition is displayed on
Tables 5 and 6.

3.1 Financial development (FI) and banking concentration

This section analyzes the effect of banking concentration on financial development (FI).
Table 3 reports the results for the full sample, which comprises all the countries analyzed, and
Table 4 presents the results for developing countries. In general, the indicators of banking
concentration present negative signs and statistical significance in all models, providing
evidence that an increase in banking concentration (BANK_5, BANK_3) leads to a reduction
 JES

Table 3.

Concentration
(FI) and Banking
Financial development
Regression results of the model–all countries
Banking concentration (BANK_5) Banking concentration (BANK_3)
(1) (2) (3) (4) (5) (6) (1) (2) (3) (4) (5) (6)

FI (1) 0.794*** 0.829*** 0.786*** 0.792*** 0.789*** 0.697*** 0.836*** 0.897*** 0.808*** 0.763*** 0.858*** 0.844***
(0.032) (0.044) (0.051) (0.068) (0.056) (0.070) (0.025) (0.025) (0.049) (0.065) (0.059) (0.075)
BANK_5(1) 0.098*** 0.138* 0.175*** 0.180** 0.214** 0.202*
(0.034) (0.071) (0.064) (0.077) (0.084) (0.107)
BANK_3(1) 0.025** 0.047** 0.098* 0.069 0.189*** 0.297***
(0.011) (0.022) (0.051) (0.059) (0.065) (0.087)
NPL (1) 0.154*** 0.055** 0.097** 0.097* 0.132* 0.032** 0.043* 0.080** 0.065* 0.197**
(0.059) (0.024) (0.045) (0.056) (0.068) (0.014) (0.024) (0.040) (0.039) (0.095)
CAR (1) 0.185** 0.184** 0.213*** 0.216* 0.211** 0.081 0.141* 0.123
(0.085) (0.090) (0.075) (0.115) (0.097) (0.050) (0.075) (0.096)
INTR (1) 0.002 0.008 0.280** 0.013 0.054 0.186**
(0.028) (0.040) (0.132) (0.025) (0.047) (0.082)
INFL (1) 0.042 0.259** 0.155** 0.234**
(0.050) (0.112) (0.072) (0.098)
GDP (1) 0.195** 0.228***
(0.079) (0.075)
CRISIS 0.222* 0.481** 0.497* 0.641** 0.593** 0.228 0.022 0.067 0.558* 0.458** 0.354 0.572
(0.121) (0.232) (0.287) (0.263) (0.292) (0.333) (0.110) (0.152) (0.333) (0.208) (0.329) (0.472)
Observations 587 594 541 593 593 613 565 536 557 590 527 528
Countries 89 89 89 89 89 89 89 89 89 89 89 89
Inst/Cross Sec. 0.48 0.22 0.28 0.22 0.29 0.25 0.50 0.51 0.30 0.24 0.28 0.28
J-statistic 47.91 21.94 25.54 19.37 23.27 17.54 50.93 51.10 29.87 22.23 23.73 17.87
p-value (0.16) (0.11) (0.14) (0.11) (0.18) (0.23) (0.14) (0.11) (0.12) (0.10) (0.13) (0.33)
AR (1) 0.47 0.48 0.40 0.46 0.45 0.47 0.44 0.44 0.40 0.48 0.42 0.45
p-value (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00)
AR (2) 0.02 0.00 0.00 0.00 0.00 0.00 0.04 0.04 0.04 0.00 0.03 0.03
p-value (0.73) (0.96) (0.96) (0.92) (0.96) (0.93) (0.47) (0.42) (0.40) (0.99) (0.59) (0.54)
Note(s): Marginal significance levels: (***) denotes 0.01, (**) denotes 0.05, and (*) denotes 0.1. White’s heteroskedasticity consistent covariance matrix was applied in
regressions. Standard errors between parentheses. GMM – uses two-step of Arellano and Bover (1995) without time period effects. GMM estimator – tests for AR (1) and
AR (2) check for the presence of first order and second-order serial correlation in the first-difference residuals. The sample is an unbalanced panel with annual data of 89
countries (61 developing countries and 28 developed countries) from 2006 to 2015. Control variables: bank nonperforming loans to total loans (NPL); bank regulatory
capital to risk-weighted assets (CAR); real interest rate (INTR); inflation index (INFL); Annual percentage growth rate of GDP at market prices (GDP); Crisis Dummy,
assumes a value of 1 for the period 2008 to 2009 and zero otherwise (CRISIS)
Regression results of the model–developing countries
Banking concentration (BANK_5) Banking concentration (BANK_3)
(1) (2) (3) (4) (5) (6) (1) (2) (3) (4) (5) (6)

FI (1) 0.804*** 0.814*** 0.843*** 0.869*** 0.858*** 0.842*** 0.856*** 0.815*** 0.864*** 0.875*** 0.876*** 0.890***
(0.023) (0.023) (0.036) (0.033) (0.027) (0.027) (0.022) (0.033) (0.021) (0.025) (0.026) (0.032)
BANK_5(1) 0.046** 0.049** 0.055* 0.060*** 0.074*** 0.077***
(0.022) (0.025) (0.033) (0.023) (0.020) (0.022)
BANK_3(1) 0.033*** 0.051* 0.024** 0.027* 0.036** 0.060***
(0.007) (0.029) (0.011) (0.015) (0.014) (0.020)
NPL (1) 0.058** 0.107*** 0.062*** 0.055** 0.070*** 0.053* 0.057*** 0.083*** 0.080*** 0.101***
(0.024) (0.040) (0.023) (0.023) (0.023) (0.031) (0.018) (0.018) (0.017) (0.023)
CAR (1) 0.210 0.230** 0.199** 0.187*** 0.152*** 0.228*** 0.238*** 0.313***
(0.129) (0.092) (0.081) (0.059) (0.042) (0.062) (0.061) (0.082)
INTR (1) 0.002 0.008 0.024 0.020 0.016 0.044**
(0.015) (0.016) (0.021) (0.018) (0.018) (0.022)
INFL (1) 0.016 0.017 0.002 0.032
(0.027) (0.021) (0.033) (0.035)
GDP (1) 0.028 0.078**
(0.032) (0.038)
CRISIS 0.245** 0.276** 0.499** 0.326* 0.323* 0.401* 0.323** 0.410** 0.338*** 0.509*** 0.489*** 0.158
(0.114) (0.130) (0.195) (0.190) (0.173) (0.227) (0.138) (0.177) (0.120) (0.156) (0.178) (0.286)
Observations 424 422 424 358 356 356 319 436 369 361 361 361
Countries 61 61 61 61 61 61 61 61 61 61 61 61
Inst/Cross Sec 0.62 0.62 0.62 0.66 0.66 0.69 0.68 0.39 0.68 0.68 0.66 0.64
J-statistic 39.03 39.63 35.79 32.03 33.16 34.34 44.06 25.03 43.28 36.02 35.52 35.38
p-value (0.29) (0.23) (0.34) (0.51) (0.41) (0.40) (0.23) (0.20) (0.16) (0.37) (0.31) (0.23)
AR (1) 0.44 0.46 0.43 0.40 0.42 0.42 0.44 0.49 0.43 0.43 0.43 0.42
p-value (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00)
AR (2) 0.33 0.04 0.00 0.03 0.03 0.01 0.05 0.00 0.06 0.05 0.05 0.02
p-value (0.53) (0.47) (0.99) (0.58) (0.64) (0.87) (0.57) (0.97) (0.32) (0.45) (0.45) (0.76)
Note(s): Marginal significance levels: (***) denotes 0.01, (**) denotes 0.05, and (*) denotes 0.1. White’s heteroskedasticity consistent covariance matrix was applied in
regressions. Standard errors between parentheses. GMM – uses two-step of Arellano and Bover (1995) without time period effects. GMM estimator – tests for AR (1) and
AR (2) check for the presence of first order and second-order serial correlation in the first-difference residuals. The sample is an unbalanced panel with annual data of
61developing countries from 2006 to 2015. Control variables: bank nonperforming loans to total loans (NPL); bank regulatory capital to risk-weighted assets (CAR); real
interest rate (INTR); inflation index (INFL); Annual percentage growth rate of GDP at market prices (GDP); Crisis Dummy, assumes a value of 1 for the period 2008 to 2009
and zero otherwise (CRISIS)
development
banking on
Effect of

Concentration
Financial development
Table 4.
financial

(FI) and Banking

 JES

Table 5.

Competition
(FI) and Banking
Financial development
Regression results of the model–all countries
Banking competition (Lerner index) Banking competition (Boone index)
(1) (2) (3) (4) (5) (6) (1) (2) (3) (4) (5) (6)

FI (1) 0.864*** 0.889*** 0.808*** 0.842*** 0.878*** 0.828*** 0.785*** 0.799*** 0.821*** 0.842*** 0.678*** 0.911***
(0.025) (0.062) (0.0314) (0.026) (0.032) (0.034) (0.059) (0.067) (0.093) (0.110) (0.230 (0.089)
LERNER (1) 0.060*** 0.049* 0.046*** 0.044*** 0.068*** 0.053***
(0.015) (0.026) (0.014) (0.013) (0.017) (0.019)
BOONE (1) 0.163 0.012 0.007 0.013 0.046 0.014
(0.539) (0.008) (0.014) (0.014) (0.050) (0.014)
NPL (1) 0.121** 0.081*** 0.061** 0.064*** 0.076** 0.063*** 0.058* 0.066* 0.145* 0.069*
(0.050) (0.028) (0.031) (0.021) (0.032) (0.023) (0.031) (0.039) (0.083) (0.040)
CAR (1) 0.056* 0.035 0.057 0.113 0.078 0.047 0.033 0.008
(0.033) (0.043) (0.061) (0.069) (0.072 (0.132) (0.130) (0.140)
INTR (1) 0.013 0.014 0.059 0.020 0.120 0.127
(0.018) (0.028) (0.043) (0.042) (0.127) (0.095)
INFL (1) 0.071** 0.107*** 0.025 0.032
(0.035) (0.038) (0.091) (0.058)
GDP (1) 0.011 0.093
(0.038) (0.066)
CRISIS 0.428*** 0.490** 0.845*** 0.561*** 0.616*** 0.627*** 0.277* 0.565** 0.537* 0.518* 1.031 0.191
(0.113) (0.242) (0.176) (0.190) (0.203) (0.229) (0.166) (0.251) (0.292) (0.310) (1.216) (0.418)
Observations 516 540 522 539 472 552 506 506 510 520 504 504
Countries 89 89 89 89 89 89 89 89 89 89 89 89
Inst/Cross Sec. 0.45 0.23 0.50 0.48 0.48 0.45 0.29 0.20 0.17 0.16 0.10 0.26
J-statistic 46.30 22.17 46.39 44.02 37.16 40.08 30.13 17.87 13.86 13.29 1.02 19.77
p-value (0.12) (0.10) (0.14) (0.12) (0.28) (0.10) (0.12) (0.16) (0.18) (0.10) (0.60) (0.14)
AR (1) 0.48 0.48 0.46 0.46 0.42 0.44 0.43 0.43 0.42 0.43 0.39 0.46
p-value (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00)
AR (2) 0.01 0.02 0.01 0.02 0.05 0.02 0.05 0.07 0.06 0.08 0.09 0.02
p-value (0.81) (0.61) (0.83) (0.62) (0.39) (0.61) (0.38) (0.24) (0.26) (0.17) (0.12) (0.68)
Note(s): Marginal significance levels: (***) denotes 0.01, (**) denotes 0.05, and (*) denotes 0.1. White’s heteroskedasticity consistent covariance matrix was applied in
regressions. Standard errors between parentheses. GMM – uses two-step of Arellano and Bover (1995) without time period effects. GMM estimator – tests for AR (1) and
AR (2) check for the presence of first order and second-order serial correlation in the first-difference residuals. The sample is an unbalanced panel with annual data of 89
countries (61 developing countries and 28 developed countries) from 2006 to 2015. Control variables: bank nonperforming loans to total loans (NPL); bank regulatory
capital to risk-weighted assets (CAR); real interest rate (INTR); inflation index (INFL); Annual percentage growth rate of GDP at market prices (GDP); Crisis Dummy,
assumes a value of 1 for the period 2008 to 2009 and zero otherwise (CRISIS)
Regression results of the model–developing countries
Banking competition (Lerner index) Banking competition (Boone index)
(1) (2) (3) (4) (5) (6) (1) (2) (3) (4) (5) (6)

FI (1) 0.909*** 0.870*** 0.889*** 0.892*** 0.898*** 0.904*** 0.880*** 0.842*** 0.903*** 0.898*** 0.870*** 0.915***
(0.014) (0.021) (0.029) (0.034) (0.029) (0.034) (0.038) (0.058) (0.037) (0.068) (0.057) (0.055)
LERNER(1) 0.029*** 0.039*** 0.040** 0.042*** 0.038** 0.040**
(0.011) (0.013 (0.016) (0.016) (0.016) (0.018)
BOONE (1) 0.016 0.012* 0.011** 0.026** 0.016* 0.013*
(0.010) (0.007) (0.005) (0.011) (0.009) (0.008)
NPL(1) 0.063*** 0.079*** 0.085*** 0.088*** 0.086*** 0.078*** 0.080*** 0.120** 0.083** 0.065*
(0.019) (0.027) (0.026) (0.025) (0.028) (0.025) (0.017) (0.055) (0.036) (0.037)
CAR(1) 0.355*** 0.401*** 0.368*** 0.381*** 0.092** 0.041 0.128* 0.150*
(0.125) (0.092) (0.090) (0.111) (0.035) (0.096) (0.077) (0.087)
INTR(1) 0.003 0.005 0.010 0.051* 0.024 0.016
(0.017) (0.016) (0.026) (0.031) (0.028) (0.021)
INFL(1) 0.024 0.024 0.026 0.022
(0.030) (0.036) (0.035) (0.040)
GDP(1) 0.004 0.041
(0.030) (0.029)
CRISIS 0.218* 0.464*** 0.665*** 0.554** 0.463** 0.456* 0.416* 0.564* 0.327* 0.749* 0.604** 0.593*
(0.122) (0.150) (0.190) (0.276) (0.234) (0.246) (0.244) (0.326) (0.181) (0.440) (0.280) (0.356)
Observations 329 328 328 334 329 329 312 358 357 308 350 306
Countries 61 61 61 61 61 61 61 61 61 61 61 61
Inst/Cross Sec. 0.70 0.70 0.70 0.71 0.70 0.70 0.47 0.27 0.51 0.27 0.40 0.48
J-statistic 39.40 39.08 34.17 28.03 32.71 32.70 31.77 14.90 30.51 12.72 20.03 24.59
p-value (0.32) (0.29) (0.46) (0.75) (0.43) (0.38) (0.13) (0.25) (0.21) (0.24) (0.22) (0.22)
AR (1) 0.41 0.43 0.37 0.36 0.37 0.37 0.41 0.42 0.42 0.43 0.41 0.40
p-value (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00)
AR (2) 0.05 0.04 0.06 0.06 0.06 0.06 0.08 0.11 0.10 0.08 0.10 0.13
p-value (0.46) (0.59) (0.40) (0.37) (0.34) (0.36) (0.32) (0.10) (0.11) (0.34) (0.12) (0.15)
Note(s): Marginal significance levels: (***) denotes 0.01, (**) denotes 0.05, and (*) denotes 0.1. White’s heteroskedasticity consistent covariance matrix was applied in
regressions. Standard errors between parentheses. GMM – uses two-step of Arellano and Bover (1995) without time period effects. GMM estimator – tests for AR (1) and
AR (2) check for the presence of first order and second-order serial correlation in the first-difference residuals. The sample is an unbalanced panel with annual data of
61developing countries from 2006 to 2015. Control variables: bank nonperforming loans to total loans (NPL); bank regulatory capital to risk-weighted assets (CAR); real
interest rate (INTR); inflation index (INFL); Annual percentage growth rate of GDP at market prices (GDP); Crisis Dummy, assumes a value of 1 for the period 2008 to 2009
and zero otherwise (CRISIS)
development
banking on
Effect of

Financial development
Table 6.
financial

Competition
(FI) and Banking
JES in financial development. These results suggest that countries with a large amount of assets
concentrated in a few banks (three or five in our analysis) constrain financial development,
i.e., diminish the relevance, accessibility and efficiency of the countries’ financial systems.
The credit risk (NPL) presents negative signs and statistical significance in all models,
implying that countries exposed to high credit risk may experiment low financial
development. Since banking behavior is forward-looking (De Moraes; Antunes and
Montes, 2016), the persistence of high levels of NPL may discourage banks to incur in
additional risk-taking, leading to low financial development. As for the CAR, the negative
signs in all models suggest the existence of a trade-off between capital regulation, measured
by the capital adequacy ratio, and financial development. Hence, the more solvent banks are,
the higher the CAR and the lower the financial development.
Regarding the macroeconomic variables, the signs and significance of the GDP
coefficients reveal a negative relationship between economic growth and financial
development (FI), both in the full sample and in the developing countries analysis. In
terms of inflation (INFL) and the interest rate (INTR), the full sample analysis shows evidence
that both variables curb financial development. Concerning the developing countries
analysis, although INFL and INTR present negative signs in all the models, only the interest
rate (INTR) is significant. These results are expected, for during periods of high interest rates
financial development is curbed. Finally, the crisis dummy evidences that financial
development is adversely affected by periods of crisis.

3.2 Financial development (FI) and banking competition

In this section we analyze the effect of banking competition (Lerner and Boone indexes) on
financial development (FI). Table 5 reports the full sample results, where all countries are
analyzed altogether, while Table 6 reports the results for the sample of developing countries.
In general, the coefficients of the Lerner index present negative signs and statistical
significance. Concerning the Boone index, the estimations involving developing countries
show the expected sign and statistical significance. The negative relationship between the
degree of competition and financial development indicates that an economic environment of
higher competitiveness leads to a higher financial development. Thus, there is evidence that
financial development can be fostered if greater incentives for competitiveness are provided.
In most of the estimations, the NPL negative signs and statistical significance evidence
that an increase in credit risk constrains financial development. It is also noteworthy that the
negative sign and statistical significance of the CAR variable in the developing countries’
analysis strengthens the existence of a trade-off between capital regulation and financial
development. At last, the crisis dummy results corroborate the effect of crises’ periods in
financial development. These results corroborate the findings in the banking concentration
analysis.
It is important to highlight that the effect of banking concentration and banking
competition concerning an alternative financial development measure, namely the credit to
GDP ratio, corroborate the results obtained in the principal analysis involving financial
development (FI) for the full sample as well as for the developing countries subsample. The
tables of results are available upon request.

4. Robustness checks
This section checks the effect of banking concentration and competition, measured by the
Hirschman-Herfindahl index (HHI) and Panzar-Rosse H-Statistic (Leon, 2015), on financial
development (FI). Concerning the HHI and H-statistic, the data are obtained from the
European Central Bank Statistical Data Warehouse and World Bank database, respectively.
The time frame of the analysis follows data availability. As for HHI, the analysis
comprehends 23 countries, spanning from 2006 to 2015. Concerning the H-Statistic, we use Effect of
data from 81 countries from 2010 to 2014 [3]. Tables 7 and 8 reports the descriptive statistics. banking on
Estimations also used the dynamic panel data method (GMM), and the econometric model
presents specification similar to model 1.
financial
development
Financial developmenti;t ¼ β0 þ Financial developmenti;t−1 þ HHIi;t−1 þ Controlsi;t−1
þ Crisisi;t þ εi;t
(2)
Financial developmenti;t ¼ β0 þ Financial developmenti;t−1 þ HStatistici;t−1
þ Controlsi;t−1 þ εi;t (3)

Table 9 shows the regression regarding the effect of HHI and H-Statistic on Financial
development. The results corroborate those found previously with the banking concentration
(Bank_5 and Bank_3) and banking competition (Lerner and Boone index). Therefore, an

No. of Standard
observations Mean Median Maximum Minimum deviation

Financial development 230 0.691 0.691 0.942 0.379 0.137

(FI)
Banking Concentration 223 0.112 0.103 0.834 0.0178 0.078
(HHI)
Control variables
NPL 222 8.027 5.210 47.750 0.200 7.634
CAR 228 14.879 14.385 35.650 7.340 3.606
INTR 221 5.112 4.619 28.791 7.690 3.759
INFL 230 2.360 2.143 15.431 4.780 2.447
GDP 230 1.554 1.761 25.557 14.814 4.353
Note(s): Control variables: bank nonperforming loans to total loans (NPL); bank regulatory capital to risk- Table 7.
weighted assets (CAR); real interest rate (INTR); inflation as measured by the consumer price index (INFL); Summary Statistics –
annual percentage growth rate of GDP market prices (GDP) HHI index sample

No. of Standard
observations Mean Median Maximum Minimum deviation

Financial development 405 0.499 0.481 1.000 0.082 0.212

(FI)
Banking Competition 401 0.596 0.614 1.248 0.087 0.219
(H–Statistic)
Control variables
NPL 400 6.903 4.105 45.300 0.480 7.063
CAR 400 16.967 16.270 35.650 1.750 4.176
INTR 397 5.1992 5.063 32.833 4.231 7.130
INFL 402 4.994 3.665 62.169 1.418 6.288
GDP 405 3.465 3.455 20.716 1.481 3.418
Note(s): Control variables: bank nonperforming loans to total loans (NPL); bank regulatory capital to risk- Table 8.
weighted assets (CAR); real interest rate (INTR); inflation as measured by the consumer price index (INFL); Summary Statistics –
annual percentage growth rate of GDP market prices (GDP) H-statistic sample
 JES

Table 9.

Competition (H-
(FI) and Banking

Statistic and HHI)

Concentration and
Financial development
Regression results of the models 2 and 3
Banking concentration (HHI) Banking competition (H-Statistic)
(1) (2) (3) (4) (5) (6) (1) (2) (3) (4) (5) (6)

FI(1) 0.798*** 0.671*** 0.315*** 0.293*** 0.339** 0.389** 0.807*** 0.786*** 0.730*** 1.027*** 0.893*** 0.839***
(0.075) (0.054) (0.079) (0.110) (0.146) (0.192) (0.230) (0.159) (0.192) (0.318) (0.280) (0.251)
H-Statistic 0.238* 0.176* 0.266* 0.220* 0.280* 0.209
(0.136) (0.176) (0.144) (0.131) (0.158) (0.133)
HHI 0.130* 0.094* 0.127* 0.148* 0.130* 0.174**
(0.072) (0.055) (0.075) (0.080) (0.073) (0.085)
NPL(1) 0.227*** 0.123*** 0.087** 0.086* 0.113** 0.068 0.081 0.195 0.294 0.079
(0.024) (0.030) (0.036) (0.043) (0.044) (0.123) (0.169) (0.181) (0.427) (0.290)
CAR(1) 0.145** 0.233*** 0.301** 0.054 0.027 0.203 0.361 0.259
(0.066) (0.081) (0.126) (0.158) (0.130) (0.264) (0.414) (0.299)
INTR(1) 0.028 0.012 0.169 0.123 0.082 0.155
(0.075) (0.055) (0.131) (0.129) (0.209) (0.227)
INFL(1) 0.208*** 0.161** 0.009 0.046
(0.077) (0.075) (0.183) (0.227)
GDP(1) 0.230*** 0.266
(0.066) (0.260)
CRISIS 1.825*** 0.237 0.184 0.001 0.510 1.270**
(0.323) (0.298) (0.295) (0.356) (0.411) (0.508)
Observations 121 169 143 138 137 139 239 222 227 218 218 213
Countries 23 23 23 23 23 23 81 81 81 81 81 81
Inst/Cross Sec. 0.78 0.78 0.78 0.78 0.78 0.78 0.08 0.17 0.12 0.13 0.13 0.15
J-statistic 12.05 14.84 15.18 15.62 13.51 14.38 2.65 9.209 4.43 3.47 3.64 4.24
p-value (0.68) (0.39) (0.30) (0.21) (0.26) (0.16) (0.62) (0.51) (0.49) (0.63) (0.46) (0.37)
AR(1) 0.41 0.42 0.40 0.40 0.42 0.48 1.69 2.30 1.69 1.77 1.86 1.80
p-value (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.09) (0.02) (0.09) (0.08) (0.06) (0.07)
AR(2) 0.03 0.15 0.02 0.007 0.006 0.02 0.83 0.62 0.73 0.09 0.07 0.39
p-value (0.83) (0.13) (0.80) (0.94) (0.94) (0.78) (0.41) (0.53) (0.47) (0.92) (0.94) (0.70)
Note(s): Marginal significance levels: (***) denotes 0.01, (**) denotes 0.05, and (*) denotes 0.1. White’s heteroskedasticity consistent covariance matrix was applied in
regressions. Standard errors between parentheses. GMM – uses two-step of Arellano and Bover (1995) without time period effects. GMM estimator – tests for AR (1) and
AR (2) check for the presence of first order and second-order serial correlation in the first-difference residuals. The sample is an unbalanced panel with annual data. A
measure of the degree of competition in the banking market (H-statistic); Herfindahl index for Credit institutions total assets (HHI); Bank Nonperforming Loans to Total
Loans (NPL); Bank Regulatory Capital to Risk-Weighted Assets (CAR); Real interest rate (INTR); Inflation as measured by the consumer price index (INFL); Annual
percentage growth rate of GDP at market prices (GDP); Crisis Dummy, assumes a value of 1 for the period 2008 to 2009 and zero otherwise (CRISIS)
increase in bank concentration measured by HHI or a decrease in competition measured by H- Effect of
Statistic can inhibit financial development (FI). The variables NPL and CAR stand out in the banking on
analysis (Model 2). They reinforce the idea that an increase in defaults undermines countries’
credit supply. Besides, the trade-off between CAR and credit remains.
financial
development

5. Conclusion
This paper analyzes, through a panel with 89 countries from 2006 to 2015, how financial
development reacts to concentration and competition. The main findings suggest that a
higher degree of banking concentration or a less competitive banking sector inhibits
countries’ financial development and the credit supply. This is also true for emerging
countries. These results suggest that the way the banking sector is structured, in terms of
concentration and competition, is important for the provision of financial services in countries
with different development levels. Therefore, the results of this study adds a new perspective
on banking market structure: a financial system concentrated or uncompetitive constrains
financial development.

Notes
1. The tables regarding countries and variables description and sources are available upon request to
the authors.
2. The tables of instruments used in this study are available upon request.
3. The tables regarding countries and variables description and sources are available upon request to
the authors.

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Corresponding author
Claudio Oliveira De Moraes can be contacted at: [email protected]

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