Does Competition Lead To Efficiency? The Case of EU Commercial Banks

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Executive Summary

Using bank level balance sheet data for commercial banks in the major EU banking markets, this paper aims to shed some light on the recent developments in competition, concentration and bank specific efficiency levels. Furthermore, using Granger-type causality test estimations, this study investigates the relationship between competition and efficiency. Results indicate that the main EU banking markets are becoming progressively more concentrated and less cost efficient. On average, banks seem to have reduced their marginal costs faster than price falls; this led to an increase in the Lerner index thus suggesting greater market power. However, the findings do not support Hick's quiet life hypothesis as they indicate that an increase in banks' monopoly power does not translate into a decrease in cost efficiency. On the other hand, results of the reverse causality tests provide no evidence that increases in efficiency precede increases in market power.

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