An Econometric Analysis of

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Bank market structure, competition, and SME
financing relationships in European regions
Mergers and Acquisitions of Financial
Institutions FDIC, Arlington, VA. 30th November
01st December 2007
Steve Mercieca Klaus Schaeck Simon
Wolfe University of Southampton Cass Business
School University of Southampton
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• What the paper does
• We investigate the determinants of multiple bank
  relationships based on
• SME firm, bank market, and financial system
  architecture characteristics.
• How do changes in bank market structure and
  competition among banks
• affect the number of bank relationships that
  SMEs maintain?

• First paper to the best of our knowledge
  that
• investigates determinants of the number of bank
  relationships maintained by SMEs
• disentangles the effects of concentration and
  competition on bank relationships
• emphasizes regional perspective

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What do we mean by bank financing
relationship? Any kind of financing activity,
e.g. firm start up, product development,
business acquisition, management buy-in/buy-out,
stock purchase, tax payments. Our definition
excludes bank relationship based only on deposit
accounts/cheque usage.

• Why are these issues important?
• a) In Europe, SMEs account for 99 of all
  companies, employ around 75
• million people and generate one in every two
  new jobs (European
• Commission, 2004).
• b) Important benefits arise from interaction
  between borrowers and banks
• (e.g. Elyasiani and Goldberg, 2004)

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• Why are these issues important? (contd)
• c) The link between structure and competitive
  conduct is not clear-cut.
• Many previous studies proxy competition by the
  degree of concentration, with the (implicit)
  assumption of an inverse relationship between the
  two!

This however gives rise to several
issues (1) Definition of a market affects
measurement of concentration (Shaffer,
2004). (2) Measures of market structure are not
necessarily related to competition (Baumol et
al., 1982). (3) Empirical evidence that
concentration and competition describe different
characteristics of banking systems (Claessens and
Laeven, 2004 Carbo et al., 2006).
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One bank relationship vs gt 1 one bank
relationship
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Market structure vs. competitive conduct
Fears that consolidation decreases the number of
banks specializing in relationship banking (e.g.
community banks) with possibly detrimental
welfare effects for local firms, especially SMEs,
these Firms access to credit, and ultimately,
economic growth. Extensively studied for the US
(e.g. Craig and Hardee, 2006 Berger and Udell,
2002 Cole et al., 2004 Berger and Frame, 2005).
Beneficial effects arising from increased
competition in banking for the provision of
banking services may be offset by greater
concentration in banking. Market power
hypothesis competition enhances access to credit
(e.g. Boot and Thakor, 2000) Information
hypothesis less competition improves credit
availability (e.g. Petersen and Rajan, 1995)
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Overview on SMEs The EU defines SMEs as
enterprises that employ fewer than 250 people,
have an annual turnover not exceeding 50 million
EUR, and/or annual balance sheet total not
exceeding 43 million EUR.

• Our data
• Taken from the 2002 ESRC survey conducted by the
  Centre for Business Research
• of the University of Cambridge.
• Survey focuses on funding of SMEs in three
  different regions in Europe (South east
• of England, Bavaria in Germany, and
  Emilia-Romagna in Italy).
• Questionnaire contains 191 questions for Germany
  and the UK, and 188 for
• Italy. 247 responses for the UK, 161 for Italy,
  and 114 for Germany.
• Questions from the survey include but are not
  limited to
• the main markets served
• the type of finance used
• whether firms have used bank finance
• the role played by banks
• whether firms make use of providers of venture
  capital

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Number of bank relationships by country
Source Survey of the financing of small and
medium sized enterprises in Western Europe.
Italian SMEs tend to maintain the highest number
of bank relationships, followed by German and
British SMEs. The UK makes up 47 of the sample,
followed by Italy (31), and Germany (22).
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Measuring competition Panzar and Rosse
H-Statistic H-Statistic measures market power by
the extent to which changes in factor input
prices are reflected in equilibrium revenues of a
bank. This measure is considered to be
analytically superior to (structural) measures
of competition because it is derived from
profit-maximizing equilibrium conditions
(Shaffer, 2004). The H-Statistic is calculated
as follows
R total revenue W1 W3 input prices (interest
expenses personnel expenses other operating
and admin expenses) Y1 Y4 control
variables H-Statistic is the sum of the
coefficients ß1 ß2 ß3.
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Estimation strategy We regress the number of
bank relationships on firm, market, and
region-specific variables. The dependend
variable is coded as 0 no bank
relationship 1 one bank relationship 2 more
than one bank relationship Caveat The survey
does not provide details beyond more than one
bank relationship.
We use both tobit and logit models (for the
decision to have more than just one bank
relationship) for the empirical setup. All
regressions control for SME characteristics,
variables that describe SME- firm relationship,
and distance. We also include environmental
variables such as regional GDP growth,
regionally active population, and concentration
in the banking system.
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Bank market structure, competition, and SME
financing relationships in European regions
Motivation/Rationale Related literature
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Empirical results
Steve Mercieca, Klaus Schaeck, and
Simon Wolfe
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• Empirical results
• Competition and concentration both enter
  positively and signficiantly when included in
  separate regressions.
• However, the sign of the coefficient for the HHI
  becomes negative when we account for the effect
  of competition as measured by the H-Statistic.
• The negative effect of consolidation (or,
  better, concentrated markets) is aligned with the
  evidence in Craig and Hardee (2007).

• These results imply
• Concentration and competition measure different
  characteristics of banking systems.
• The degree of competition should not be proxied
  with concentration measures.

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Empirical results (contd)
The effects of competitive conduct and market
structure appear to cancel out each
other. Regional characteristics such as access
to banking facilities, regional growth, regional
population and regional degree of innovation all
tend to be positively associated with the number
of bank relationships.
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Empirical results (contd)
Financing and legal obstacles are inversely
related to bank soundness. Time and cost to
start a business motivate banks to set up
multiple bank relationships. SMEs operating in
more open banking systems are more likely to have
multiple bank relationships. No effect on the
significance/sign of H and HHI in these
extensions.
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• Robustness checks
• Our inferences are insensitive to
• Alternatively computed H-Statistics
• (interest revenue as dependent variable)
• b) Alternative measures of market structure
• (3 bank concentration ratio instead of HHI)
• Using a logit model with marginal effects rather
  than a Tobit model

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Economic significance of the effects of HHI and
H-Statistics We assess the affect of HHI and
H-Statistics using marginal effects. Increasing
the HHI by one percent decreases the probability
of having an additional bank relationship by
0.04 percent. However, increasing the
H-Statistic by one percent increases the
probability of having an additional bank
relationship by 0.05 percent.
The negative effect of concentration is offset by
increasing competition.
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• Summary
• Competition and concentration appear to be
  different characteristics of banking systems.
• Our results support the market power
  hypothesis according to which firms maintain more
  bank relationships in more competitive banking
  systems.
• (2) We uncover contrasting independent effects
  arising from both concentration and competition.
• (3) Regional characteristics also impact on the
  number of bank relationships.
• (4) Firm size, bank role, and distance are also
  important determinants of the number of bank
  relationships.

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• Caveats/Qualifiers
• The comparatively small sample size recommends
  that we exert some
• caution when interpreting the results.
• However, our findings are aligned with a growing
  body of empirical work
• that disentangles the effects of concentration
  and competition.
• We refrain from interpreting the results in a
  causal sense.

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• Concluding remarks
• To the best of our knowledge, our study is the
  first one that investigates the determinants of
  SME-bank financing relationships in Europe.
• We also focus on the effect of changes in bank
  market structure on on the number of bank
  relationships maintained by SMEs.
• Our results suggest that policies that promote
  competition among banks may have potential to
  facilitate access to finance for SMEs.
• Policymakers concerns about the adverse
  ramifications arising from consolidation in
  banking may be overstated.