Economics Letters 101 (2008) 13–16

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Economics Letters
j o u r n a l h o m e p a g e : w w w. e l s ev i e r. c o m / l o c a t e / e c o n b a s e

Bank competition and regional differences

Paolo Coccorese ⁎
Department of Economics and Statistics, CELPE and CSEF, University of Salerno, Italy

A R T I C L E I N F O A B S T R A C T

Article history: We estimate banks' conduct for Italian regions, then regress the behavioural parameters on selected
Received 3 October 2007 indicators of local banking market structure and macroeconomic performance. This allows to identify some
Received in revised form 14 February 2008 factors explaining why banks exhibit different patterns of conduct across regions.
Accepted 26 March 2008
© 2008 Elsevier B.V. All rights reserved.
Available online 8 April 2008

Keywords:
Banking
Competition
Market structure
Conduct

JEL classification:
G21
L10
L13

1. Introduction degree of competition. Afterwards, we regress this index on a number

An important process of consolidation has characterized the banking
industries of many industrialized countries in recent years, essentially
due to the widespread lowering of entry barriers and the aim of ex-
ploiting scale and scope economies. However, there is no particular
evidence that the increased concentration has had detrimental effects
on market competition.
The structure of the banking sector is recognized to have a funda-
mental role in economic growth and development. Banks with sig-
nificant market power might increase prices, causing inefficient
resource allocation and reduced capital accumulation and growth.
On the other hand, a concentrated banking market could make easier
to cope with the lack of information about people asking for funds and
projects to be financed, thus reducing problems of adverse selection
and moral hazard.
In this paper, we assess the level of competition in the Italian
banking industry at a regional level, then identify some factors that
help to explain differences in this measure among areas. We employ
the industrial organization approach suggested by Bresnahan (1982,
1989) and Lau (1982), which requires industry aggregate data and
allows the direct estimation of a parameter providing a measure of the
⁎ Università degli Studi di Salerno, Dipartimento di Scienze Economiche e Statistiche,
Via Ponte don Melillo, 84084 Fisciano (SA), Italy. Tel.: +39 089 962338; fax: +39 089
962049.
E-mail address: coccorese@unisa.it.
of structural and environmental indicators in order to inspect their
role on competitiveness among local banks.
Three features of this approach are worth mentioning. First, our
measure of competition is a clear benchmark for evaluating banks'
conduct, being a point estimate of the deviation of aggregate banking
output from the competitive level, unlike the H-statistic (Panzar and
Rosse, 1987), used in other similar studies but nonetheless requiring
stronger assumptions on market conditions. Second, like other
countries Italy experiences a sharp difference in the level of economic
activity between areas, with economic performance generally wor-
sening as one moves from Northern to Southern regions: this makes
interesting the investigation on whether these differences reverberate
in the degree of local banking competition. Third, studying regions
within the same country allows a more precise identification of the
aforementioned relationship, because of the homogeneity of legal,
historical, cultural and social factors that usually plays a crucial role in
influencing the macroeconomic performance of the areas but is hard
to be captured in a cross-country framework (Levine et al., 2000).
2. The model
We assume that a profit-maximising bank will choose a level of
output (loans) that equalizes marginal revenue to marginal cost. Let
the demand function, for region r and time t, be the following:
Qrt ¼ Qrt ðPrt ; Xrt ; dÞ; ð1Þ

0165-1765/$ – see front matter © 2008 Elsevier B.V. All rights reserved.
doi:10.1016/j.econlet.2008.03.019
14 P. Coccorese / Economics Letters 101 (2008) 13–16

where Qrt is the aggregate level of loans, Prt is the loan rate, Xrt is a Table 1
vector of exogenous variables shifting the demand curve, and δ rep- Summary statistics for the simultaneous-equation model

resents a vector of unknown parameters to be estimated. Mean S.D. Min Max

The perceived marginal revenue function for a generic bank i may
Q (a) 36,782.0 52,254.7 736.3 299,669.3
be written as
P (b) 8.79 2.92 4.66 16.21
Z (b) 4.90 2.74 1.99 10.73
qirt ðd Þ Y (a) 56,795.1 53,371.7 3028.9 240,199.2
MRirt ¼ Prt þ kirt AQrt ðdÞ
; ð2Þ
POP (c) 2856.4 2258.6 116.9 9319.9
APrt
BR (d) 1377.4 1242.8 74.0 5939.0
TC (a) 2174.5 2521.5 50.6 14,319.0
where the positive unknown parameter kirt (ranging between 0 and 1) ω1 (b) 2.51 1.65 0.52 6.11
measures the competitiveness of oligopoly conduct. When kirt = 0, ω2 (e) 49.55 4.09 37.96 60.06
each bank acts as though marginal revenue coincides with market
(a) Millions euro (expressed in 2000 values); (b) Percentage values; (c) Thousands units;
demand, so that price equals marginal cost and the behaviour is (d) Units; (e) Thousands euro (expressed in 2000 values).
perfectly competitive. When kirt = 1, bank i chooses price and output
according to the industry marginal revenue curve, implying joint
monopoly or perfect collusion. Intermediate values of kirt indicate
various degrees of imperfect competition or collusion. The competitive index kr is correctly identified through the simul-
After aggregating for banks, we can refer to a single parameter krt, taneous estimation of Eqs. (4) and (6).
measuring the average conduct in market r at time t (Bresnahan, 1989).
The equilibrium condition for the generic bank is 3. Estimation results

Qrt ðd Þ
Prt  MCrt ¼ krt AQrt ðd Þ
: ð3Þ
APrt
It measures the deviation of price from marginal cost MC, and
therefore from the competitive price level1.
Our index of market power krt will be estimated as if it were
constant over time. However, we will allow it vary across markets
(regions). For its identification, we need a simultaneous model with a
demand equation and a supply relation.
The demand function takes the following semi-logarithmic form:
lnQrt ¼ a1 Prt þ a2 Zt þ a3 Yrt þ a4 POPrt þ a5 BRrt þ a6 TIME þ ar þ ert : ð4Þ
Here, Qrt and Prt are as before; Zt is the interest rate of 3-month
government bonds, a proxy for the price of a substitute for bank loans;
Yrt is Gross Domestic Product, controlling for the level of demand;
POPrt measures the population, and accounts for the absolute market
size; BRrt is the number of branches, allowing for the banks' network
size effect; TIME helps to consider possible trend effects; finally, αr
represents the constant associated to each region.
The supply relation reproduces Eq. (3). We suppose that marginal
cost originates from a translog cost function with two inputs (deposits
and labour) and one output (loans), being
TCrt
MCrt ¼ ðb0 þ b1 lnQrt þ b2 lnx1rt þ b3 lnx2rt þ b4 lnTIMEÞ; ð5Þ
Qrt
where TCrt is total cost, ω1rt and ω2rt are the exogenous input prices, and
TIME is included to capture the role of technological change over time.
In order to constrain the marginal cost function to be homogeneous of
degree one in input prices, we impose the restriction b2 +b3 = 0.
Substituting Eq. (5) in Eq. (3), and considering the semi-logarithmic
nature of the demand equation, the supply function becomes
TCrt kr
Prt ¼ ðb0 þ b1 lnQ rt þ b2 lnx1rt þ b3 lnx2rt þ b4 lnTIMEÞ  þ urt : ð6Þ
Qrt a1
The price of funds, ω1, is measured through the regional interest
rate on deposits. The price of labour, ω2, is proxied by the average
wage rate of the financial intermediation sector. Total cost is equal to
the sum of interest expenses (deposit rate times deposits) and labour
costs (assumed equal to the salaries paid by financial intermediaries).
1
Shaffer (1993) demonstrates that −k is also an estimate of the percentage deviation
of total industry output from the optimal level of production that characterises the
competitive equilibrium.
Our aggregate data (sources: Banca d'Italia and Istat) cover the
twenty Italian regions2 for the period 1995–2004. Economic figures
have been deflated by means of the GDP deflator. Table 1 reports some
descriptive statistics on the dataset.
Aiming to evaluate the degree of banks' market power at a national
level, in the main macro-areas, and for each region, three different
specifications of the model have been estimated. For Models 2 and 3,
dummy variables for each sub-area have been associated to the index
kr (Shaffer, 2001). Results are shown in Table 2.
Regarding the demand equation, all coefficients are significant. As
expected, P has a negative sign, while the coefficient of Z is positive.
Along with other studies, equilibrium is set where the demand for
loans comes out to be inelastic (Shaffer and DiSalvo, 1994). The cross-
price elasticity is smaller than the absolute own-price elasticity (see
Table 2): hence, banks are able to soften price competition. The
variables POP and BR exhibit a positive coefficient, meaning that wider
and better served markets warrant banks a higher demand. The time
trend signals that loans increased in size during the considered years.
The unpredicted negative coefficient of Y deserves a brief discussion.
Some of the regressors included in Eq. (4)—namely, Y, POP and BR—show
to be highly correlated3. This multicollinearity is likely to explain the
negative sign of Y, since positive correlation between variables may lead
to negative covariance between their estimated coefficients (Johnston,
1972, p. 161). However, even if dropping some of the above control
variables may alleviate the multicollinearity problem, it could lead to an
incorrect specification of our model that might seriously and adversely
affect the true values of all parameters, including the behavioural ones
(Gujarati, 2004, p. 366; Wooldridge, 2003, p. 97). We have nonetheless
explored the robustness of the coefficient of Y to alternate specifications
of the three models that omit the correlated variables: by dropping POP
only, a3 keeps its negative and significant sign; by dropping BR only, a3
is not significant; by dropping POP and BR, a3 becomes positive and
significant, but both a1 and a2 turn out to be statistically indistinguish-
able from zero.
In the supply equation, the marginal cost coefficients are generally
significant, while the variable TIME is significant in two of three re-
gressions, where it takes a negative sign: so, improvements in tech-
nology have had an important role in reducing loan prices.
2
Following the classification of the Central Bank of Italy, we can divide them in four
macro-areas: North-West (Piemonte, Valle D’Aosta, Lombardia, Liguria); North-East
(Veneto, Trentino Alto Adige, Friuli Venezia Giulia, Emilia Romagna); Center (Toscana,
Umbria, Marche, Lazio); South and Islands (Abruzzi, Molise, Campania, Basilicata,
Puglia, Calabria, Sicilia, Sardegna).
3
Particularly, rY,POP = +0.9347, rY,BR = +0.9791 and rPOP,BR = + 0.8895.
 P. Coccorese / Economics Letters 101 (2008) 13–16 15

Table 2
System estimation results

Model 1 Model 2 Model 3

Variable Coefficient t-value Coefficient t-value Coefficient t-value

Demand equation (dependent variable: lnQ)

P a1 −0.0423 −3.16 ⁎⁎⁎ −0.0414 −2.99 ⁎⁎⁎ −0.0293 −2.10 ⁎⁎
Z a2 0.0377 2.65 ⁎⁎⁎ 0.0404 2.75 ⁎⁎⁎ 0.0325 2.19 ⁎⁎
Y a3 −0.0126 −2.42 ⁎⁎ −0.0137 −2.54 ⁎⁎ −0.0145 −2.65 ⁎⁎⁎
POP a4 0.0008 2.55 ⁎⁎ 0.0008 2.61 ⁎⁎⁎ 0.0008 2.57 ⁎⁎
BR a5 0.0005 3.54 ⁎⁎⁎ 0.0005 3.58 ⁎⁎⁎ 0.0005 3.42 ⁎⁎⁎
TIME a6 0.0241 3.92 ⁎⁎⁎ 0.0271 4.25 ⁎⁎⁎ 0.0320 4.95 ⁎⁎⁎
2
Adj R 0.9925 0.9928 0.9930

Price-cost margin equation (dependent variable: P)

CONST b0 97.9811 8.32 ⁎⁎⁎ 115.0399 13.35 ⁎⁎⁎ 61.4277 5.21 ⁎⁎⁎
lnQ b1 1.5430 1.86 ⁎ 1.1915 1.99 ⁎⁎ 8.3641 7.46 ⁎⁎⁎
lnω1 b2 12.1218 2.85 ⁎⁎⁎ 25.8402 7.82 ⁎⁎⁎ 35.1778 12.85 ⁎⁎⁎
lnω2 b3 −12.1218 −2.85 ⁎⁎⁎ −25.8402 −7.82 ⁎⁎⁎ −35.1778 −12.85 ⁎⁎⁎
lnTIME b4 −4.5725 −1.51 −6.8854 −3.04 ⁎⁎⁎ −5.8298 −3.32 ⁎⁎⁎

Conduct parameter (k)

Italy 0.1497 2.94 ⁎⁎⁎ – – – –
North–West – – 0.2151 2.93 ⁎⁎⁎ – –
North–East – – 0.2064 2.93 ⁎⁎⁎ – –
Center – – 0.2175 2.93 ⁎⁎⁎ – –
South and Islands – – 0.2803 2.95 ⁎⁎⁎ – –
Piemonte – – – – 0.1500 2.07 ⁎⁎
Valle D'Aosta – – – – 0.2487 2.08 ⁎⁎
Lombardia – – – – 0.1326 2.07 ⁎⁎
Trentino A.A. – – – – 0.1705 2.08 ⁎⁎
Veneto – – – – 0.1677 2.08 ⁎⁎
Friuli V.G. – – – – 0.1521 2.07 ⁎⁎
Liguria – – – – 0.1898 2.08 ⁎⁎
Emilia R. – – – – 0.1497 2.08 ⁎⁎
Toscana – – – – 0.1580 2.08 ⁎⁎
Umbria – – – – 0.2029 2.09 ⁎⁎
Marche – – – – 0.1582 2.08 ⁎⁎
Lazio – – – – 0.1495 2.07 ⁎⁎
Abruzzi – – – – 0.2169 2.09 ⁎⁎
Molise – – – – 0.2707 2.09 ⁎⁎
Campania – – – – 0.2156 2.08 ⁎⁎
Puglia – – – – 0.2128 2.08 ⁎⁎
Basilicata – – – – 0.2748 2.09 ⁎⁎
Calabria – – – – 0.2686 2.09 ⁎⁎
Sicilia – – – – 0.2175 2.09 ⁎⁎
Sardegna – – – – 0.2186 2.09 ⁎⁎
2
Adj R 0.8662 0.9314 0.9592
N. of observations 200 200 200

Elasticities
P −0.3719 −0.3639 −0.2581
Z 0.1847 0.1982 0.1596
Y −0.7159 −0.7803 −0.8254
POP 2.2425 2.3889 2.3832
BR 0.6232 0.6557 0.6349

Systems have been estimated by means of non-linear three-stage least squares.

Instruments are: levels and logs of lagged Q and P; levels and logs of Z, Y, POP, BR, average total cost, ω1, ω2, number of employees, deposits, consumption, investment, and time
trend; regional dummies.
The demand equation includes a full set of regional dummy variables (coefficients are not reported).
Significance for the parameter estimates: ⁎⁎⁎ = 1% level; ⁎⁎ = 5% level; ⁎ = 10% level.

Regarding the various kʼs, in all specifications we strongly reject
the hypotheses of both perfect collusion and perfect competition.
Therefore, the Italian banking market exhibits an imperfect degree of
competition. For the whole country, it amounts to 0.150, meaning that
banking output has been about 15% below the competitive equili-
brium level during the sample period. This evidence proves that
competition is nevertheless intense and has not been harmed by the
recent consolidation.
About the macro-areas, competition is more intense in the North-
Eastern part (0.206), also if North–West and Center exhibit slightly
lower values (0.215 and 0.218, respectively); it is less severe in the
South and Islands, where k = 0.280. The above findings parallels those
by Coccorese (2004), who found that the degree of competition of
local banking markets reduces as one moves from North to South, and
are also clearly confirmed by the estimated parameters of Model 3.
4. The determinants of banks' conduct
In order to ascertain the factors that can significantly explain the
differences in competitiveness across Italian local banking markets,
we regress the estimated values of regional k's on two separate groups
of characteristics for each region r, regarding the structure of banking
markets and the macroeconomic features, respectively (all variables
representing average values for the years 1995–2004).
16 P. Coccorese / Economics Letters 101 (2008) 13–16

Table 3 most efficient banks have lower costs and higher profits, being there-
Determinants of local banking market power fore able to increase their market share (even through mergers and
a) Structural factors acquisitions) and exploit market power at the same time.
Variable Coeff t The second regression, which controls for environmental factors,
HHI 0.1970 3.12 ⁎⁎⁎ makes clear that there is no relationship between per capita GDP and
BRBANK −0.0030 −6.68 ⁎⁎⁎
banking competition, and also that the level of unemployment cannot
BRPOP −0.1329 −3.19 ⁎⁎⁎
COSTBR −0.0411 −3.61 ⁎⁎⁎ be considered a determinant of banks' marker power. In contrast, com-
NC 0.3487 7.20 ⁎⁎⁎ petitiveness is significantly and positively affected by the bad loans ratio:
SI 0.3542 11.30 ⁎⁎⁎ therefore, when this ratio increases banks tend to soften competition
Adj R2 0.8785
and raise prices in order to compensate the higher degree of risk. The
DW statistic 1.84
N. observations 20
coefficient of LOANGDP is also significant, and its negative sign attests
that more developed financial markets are characterized by a higher
b) Macroeconomic factors degree of banking competition.
Variable Coeff t
GDPPOP 0.0034 1.48
5. Conclusion
UNEMP −0.1473 −1.13
BADL 0.4815 4.58 ⁎⁎⁎
LOANGDP −0.1431 −5.36 ⁎⁎⁎ We have proposed a two-step estimation procedure for evaluating
NC 0.1580 2.37 ⁎⁎ the role of structural and environmental variables on the conduct of
SI 0.1681 3.05 ⁎⁎⁎ banks at a local level, with an application to Italy.
Adj R2 0.8594
DW statistic 2.12
In spite of the recent consolidation trend, Italian banks globally
N. observations 20 enjoy little market power, but its level is quite different across regions.
A remarkable role is played by the structure of local banking markets:
Dependent variable: regional k.
t-statistics are adjusted for heteroskedasticity (White's correction method). competition reduces when regional markets are concentrated, there
Significance for the parameter estimates: ⁎⁎⁎ = 1% level; ⁎⁎ = 5% level; ⁎ = 10% level. are few branches, and banks exhibit a higher level of efficiency. Re-
garding the macroeconomic variables, per capita GDP and unemploy-
ment do not appear to affect banks' conduct, while important factors
The equations are: that adversely impact competition are credit riskiness and the poor
development of financial markets.
kr ¼ g0 þ g1 HHIr þ g2 BRBANKr þ g3 BRPOPr þ g4 COSTBRr
ð7Þ
þ DNC þ DSI þ sr Acknowledgement

and
kr ¼ d0 þ d1 GDPPOPr þ d2 UNEMPr þ d3 BADLr þ d4 LOANGDPr
þDNC þ DSI þ υr :
In Eq. (7), HHI is the value of the Herfindahl–Hirschman index
(computed on branches), an index of market concentration; BRBANK is
the average number of branches per bank, a measure of the network
size of credit institutions; BRPOP is the number of branches per million
inhabitants, a proxy for the local density of branches; COSTBR is the
average total cost per branch (in millions euro) and is included to take
into account banks' efficiency.
In Eq. (8), GDPPOP is the per capita GDP (in thousands euro),
UNEMP the unemployment ratio, and BADL the bad loans to total loans
ratio. They help to control for differences in local economic develop-
ment, while LOANGDP, the loans to GDP ratio, is included as a proxy for
local financial development.
Both equations contain the dummy variables DNC and DSI for cap-
turing possible omitted factors specific to North and Center (12 regions)
and South and Islands (8 regions), respectively. This partition stems from
the similarity of the estimated kʼs that characterizes Northern and
Central Italy with respect to the other regions.
Table 3 displays the estimation results. According to the first re-
gression, regional banking markets are significantly characterized by
less competition when they are more concentrated, the branch net-
work is narrow, the density of branches is low, and banks' efficiency is
high (i.e. their average cost per branch is low). However, the sign and
significance of both HHI and COSTBR could be also interpreted in the
light of the efficiency hypothesis (Demsetz, 1974; Smirlock, 1985): the
The author would like to thank an anonymous referee for helpful
comments and suggestions.
ð8Þ
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