The Effects of Regulatory Reform on Competition in the Banking Industry

Abstract

The paper analyzes the evolution of competitive conditions in the Italian banking industry using firm-level balance sheet data for the period 1984-1997. Regulatory reform, large-scale consolidation, and competitive pressure from other European countries have changed substantially the banking environment, with potentially offsetting effects on the overall degree of competitiveness. We find that competitive conditions, relatively unchanged until 1992, have improved substantially thereafter, as signaled by the decline in estimated markups. Also, we analyze for the first time the long-run impact of the consolidation process on competition and find no evidence that banks involved in mergers and acquisitions gained market power; at the same time, they exhibit lower than average marginal costs. Finally, after controlling for various factors that may have determined the time pattern of banks' estimated markups, we still detect a significant unexplained drop in our competitive conditions indicators after 1992. Overall, our evidence is consistent with the hypothesis that the deregulation process, which culminated with the implementation of the Second Banking Directive in 1993, significantly contributed to improving bank competition and that it may also have been an important determinant of the consolidation process recorded by the Italian credit system during the 1990s.