TESTING PROFIT AND STRUCTURE RELATIONSHIP IN THE EUROPEAN BANKING MARKETS USING EFFICIENCY MEASURES

Abstract

This paper provides a comparison between the developed and developing European countries through investigating the profit–structure relationship in the banking industries. The reduced-form profit equations are estimated for each group of countries for the period 1995–2006. The results suggest that the inclusion of X-efficiency and scale efficiency directly in the reduced-form profit equation is crucial in explaining the bank profit–structure relationship in the European banking markets. When we control for direct measures of efficiency, the market share and concentration coefficient become insignificant in all regressions. The results support the efficiency versions of the efficient-structure hypothesis over the relative market power and structure–conduct–performance hypothesis. For the developing economies of Europe, the findings of the paper indicate that efficiency is a crucial factor for establishing a sound banking system and the banks in these countries should increase their scale of operations to attain an optimal profit level.