A profit elasticity approach to measure banking competition in Italian credit markets

As in other industries, competition in banking is potentially beneficial to efficiency and social welfare. Unfortunately, the task of measuring such competition is not straightforward: according to the empirical literature, traditional metrics to measure competition may fail because they do not correctly account for entry barriers, product substitutability, or the concentration and reallocation of market shares among banks. In this study we explore new measurements of competition, based on the Profit Elasticity, which can limit previous drawbacks, in order to assess the significant changes in the Italian banking market over the last two decades (1994-2013), when the most serious crisis occurred. We focus on competition dynamics over time, across bank clusters and geographical areas. Our main findings suggest that deregulation and M&A activity increased the extent of competition, while the financial turmoil reduced it, in line with other international evidence. Moreover, mutual banks faced relatively less competitive local markets, mostly owing to the informational barriers that they can impose on non-local intermediaries, and banking competition is heterogeneous across Italian macro-regions.