Competition and financial institutions and markets development: a dynamic panel data analysis

Abstract

Purpose

This study aims to shed new light on the nexus between market competition and financial development (FD), using the new FD index developed by the IMF, covering financial institutions and markets access, depth and efficiency.

Design/methodology/approach

The author uses panel data from 140 countries over 2000–2014 period and a dynamic generalized method of moments (GMM) model, along with a sensitivity analysis over 2008 financial crisis.

Findings

Strong evidence of the positive impact of market competition, as measured by Boone index, on financial institutions and markets development is found, whereas banks concentration has a damaging effect on FD. Commonly used Lerner index is found to be irrelevant. Interestingly, none of the competition indexes in this study affects financial institutions returns, which hold even over 2008 financial crisis, likely at the expense of depth and access in developing countries. Institutions, as proxied by control of corruption, have broader positive impact on FD, particularly on financial markets. These findings have important implications for developing countries keen to foster the development of their financial system.

Practical implications

Policymakers should take into consideration that FI are unlikely to undertake deep improvements in terms of credit allocation depth and inclusion on a volunteer basis, unless constrained by regulations. When promoting bank competition, it is recommended to diversify methods targeting market competition, notably by promoting financial business diversification and intermediary efficiency, and tackling collusion arrangements or interest groups influence. Second, it is important to support households and small and medium enterprises’ access to finance. Third, it is highly recommended to promote good institutions given their overall beneficial role in promoting the financial system as a whole, notably financial markets.

Originality/value

To the best of the author’s knowledge, this study is the first to fully use the new IMF Financial Development index. It covers financial institutions and markets access, depth and efficiency, whereas most of previous findings focus on access to credit or cost of credit. Besides, the study uses a larger panel data from 140 countries over 2000–2014 period and a dynamic GMM estimator, along with a sensitivity analysis over (2007–2009) crisis. By exploring the impact of three different competition indicators, namely, Boone, Lerner and banks concentration indexes, the study responds to the concerns regarding the limitations of each of them.

Citation

Abdmoulah, W. (2021), "Competition and financial institutions and markets development: a dynamic panel data analysis", Journal of Financial Economic Policy, Vol. 13 No. 5, pp. 539-564. https://doi.org/10.1108/JFEP-05-2020-0106