Academic journal article Journal of Economics and Finance

The Effect of Banking Market Structure on the Volatility of Growth of Manufacturing Sectors in Developing Countries

Academic journal article Journal of Economics and Finance

The Effect of Banking Market Structure on the Volatility of Growth of Manufacturing Sectors in Developing Countries

Article excerpt

Published online: 28 June 2011

© Springer Science+Business Media, LLC 2011

Abstract I explore the effect of banking concentration and banking competition on the volatility of the growth of value added of manufacturing sectors in the developing countries. In this paper, I bring together two strands of literature, one that discusses the effect of financial intermediation on volatility of growth and another one that discusses the effect of banking concentration and competition on credit access. Following the industrial organization literature, I look at the effect of banking competition and banking concentration on the volatility of manufacturing sectors separately. I find that banking concentration has a dampening effect on the volatility of growth of the industries. On the other hand, I find that as banking competition increases, the volatility of the growth of industries increases, also.

Keywords Banking . Concentration . Competition . Value Added . Manufacturing Sectors . Volatility

JEL Classification D4 . G21 . L11 . O16

(ProQuest: ... denotes formulae omitted.)

1 Introduction

The effect of financial intermediaries on real output has generated a heated debate in the literature. In the last decade, a consensus has been reached that higher financial intermediation facilitated higher economic growth, where Rajan and Zingales (1998) have put a cornerstone in the literature. To evaluate the effect of financial intermediaries on real output another important issue is to look whether an increase in financing through financial intermediaries has any effect on the volatility of output. Based on this debate, in this paper, I study the effect of banking competition and banking concentration on the volatility of output at industrial level using data from a group of developing countries. I find empirical evidence that banking competition increases the volatility of the growth of manufacturing sectors, while banking concentration reduces their volatility.

From the theoretical point of view, the effect of banking development on the volatility of output is ambiguous. Morgan et al. (2004) suggest that improved access to banking finance allows firms to smooth out their idiosyncratic shocks. However, the effect of banking development on volatility of economic growth can be affected by the stage of the development of the country (Aghion et al. 2004), the type of shocks that the economy faces, such as monetary or real shocks (Bacchetta and Caminal 2000), or whether the economy faces credit demand versus credit supply shocks (Morgan et al. 2004).

No consensus has been reached on the effect of banking development on volatility of economic growth in the empirical studies, also. Denizer et al. (2002) find that countries with more developed financial sectors experience less fluctuation in the growth of real per capita output, consumption and investment. On the other hand Easterly et al. (2001) show that between financial development (measured as credit to private sector) and aggregate volatility there is a U-shaped relationship. Comin and Philippon (2005) suggest that the effect of financial development on the volatility of growth depends on aggregation level, and show a positive relationship of financial development to firm level volatility. On the other hand, Correa and Suarez (2008) exploiting the staggered timing of state-level bank deregulation show a negative relationship of US banking deregulation and firm-level volatility.

While there is a discussion about the effect of financial development on the volatility of economic growth, the main focus of this paper is to look at the effects of banking competition and banking concentration on the sectoral-level volatility. The novelty of this study is that it brings together two strands of the literature. One strand of the literature looks at the effect of financial intermediation on volatility of economic growth and the second one looks at the effect of banking concentration and banking competition on the credit access. …

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