Banking Competition and Efficiency: A Micro-Data Analysis on the Czech Banking Industry

Banking competition is expected to provide welfare gains by reducing monopoly rents and cost inefficiencies, favouring a reduction of loan rates and then an increase in investment. These expected gains are a major issue for transition countries in which bank credit represents the largest source of external finance for companies. With the use of quarterly data for Czech banks, this paper aims to estimate the effects of banking competition in the Czech Republic. First, we measure the level and evolution of banking competition between 1994 and 2005. Competition is measured by the Lerner index on the loan market, using data on loan prices. We find no improvement in banking competition during the transition period. Second, we investigate the relationship and causality between competition and efficiency. We perform a Granger-causality-type analysis that supports negative causality only running from competition to efficiency. Therefore, our results reject the intuitive ‘quiet life’ hypothesis and indicate a negative relationship between competition and efficiency in banking. Comparative Economic Studies (2008) 50, 253–273. doi:10.1057/palgrave.ces.8100248