Academic journal article Research in Applied Economics

Panel Granger Causality between Bank Efficiency and Market Concentration in the European Union

Academic journal article Research in Applied Economics

Panel Granger Causality between Bank Efficiency and Market Concentration in the European Union

Article excerpt

Abstract

This paper seeks to contribute to the literature with the test of the panel Granger causality relationship running not only from bank efficiency to bank market concentration, but also the reverse causality from concentration to efficiency. For the measurement of bank efficiency, we adopt Data Envelopment Analysis (DEA) and for the bank market concentration we use the Herfindahl-Hirschman Index (HHI). The findings confirm the relative complexity of this relationship, but they are generally in line with the structure conduct performance (SCP) paradigm and the suggestions that the increase of the banks' market power will contribute to inefficiency. Within a panel of 27 EU countries over a relatively long time period, from 1996 to the onset of the 2008 financial crisis, there is evidence that the most cost-efficient commercial and savings banks operated in less concentrated markets.

Keywords: efficiency; concentration; Granger causality; European banks

(ProQuest: ... denotes formulae omitted.)

1. Introduction

Economic theory generally states that in the presence of perfect information, market competition is associated with efficiency, while the existence of market power is synonymous with less competitiveness and inefficiency. There is also a general consensus that financial markets are characterized by the existence of asymmetric information and in order to prevent adverse selection and moral hazard, it is recommended that trust should be increased, particularly through the establishment of long-lasting relationships between the banking institutions and their clients. These lasting relationships based on trust may be associated with bank market power and may also be considered to be a necessary condition of bank efficiency. Authors like Demirgüç-Kunt and Levine (2000) suggest that the relationship between bank efficiency and bank market concentration is complex and depending on the banking market specific characteristics, this relationship may be either positive or negative.

There is a strand of literature devoted to the discussion and testing of the relationships between competitiveness and efficiency of banking markets. Most of these studies concentrate on the structural approach and mainly test the structure conduct performance (SCP) hypothesis, which considers that bank market concentration is inversely related to bank market competition (a hypothesis supported by such authors as Bikker and Haaf, 2002; Deltuvaite et al., 2007; and rejected, among others, by Classens and Laeven, 2004). Other papers analyses the reverse relationship and test the possible influence of bank efficiency on market concentration, in the context of the efficient structure hypothesis (tested, among others, by Punt and Van Rooij, 2003; Weill, 2004).

However, not many works have concentrated simultaneously on these two relationships and used Granger causality estimations to test the possible causality not only between bank concentration and efficiency, but also the reverse, i.e. between bank efficiency and market concentration (three exceptions are to be found in Schaeck and Cihak, 2008, Pruteanu-Podpiera et al., 2008, and Casu and Girardone, 2009).

This paper is a contribution to the empirical analysis of the relationship between bank efficiency and bank market concentration in the European Union. The main contributions are to be found not only in the application of a panel Granger causality approach, but also in the use of a panel of 27 EU countries over a relatively long time period: from 1996 to 2008, taking into account that by the middle of the 1990s, Europe was preparing for the implementation of the single currency and many of the then-member states were adapting to new market conditions, whereas 2008 may be considered to mark the onset of the current financial crisis in Europe.

The findings confirm the relative complexity of the relationship between bank efficiency and market concentration, although they generally point to a negative causation running not only from efficiency to concentration, but also from concentration to efficiency. …

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