Financial development and local growth: evidence from highly disaggregated Italian data

Abstract

We test the nexus between local financial development and economic growth upon Italian data highly disaggregated at the territorial level, paying particular attention to the role of local banking market structure. We specify a growth model where a qualitative measure of financial development, bank profit efficiency, is considered in conjunction with a customary quantitative measure of financial development. The model is estimated on panel data over the period 2001 to 2010. The evidence suggests that both indicators of financial development have a significant impact on GDP per worker, especially when considering areas characterized by a larger number of cooperative banks. Results are not much affected by the occurrence of the ongoing recession.

Keywords:

• financial development
• economic growth
• profit efficiency
• frontier analysis
• banking efficiency

JEL Classification:

• D24
• G21
• L89

Acknowledgements

We would like to thank Paolo Coccorese and Ornella Wanda Maietta for helpful comments on a previous draft. The usual disclaimer applies.

Notes

¹ This is a fairly high level of disaggregation. A Sistema locale del lavoro is a group of municipalities akin to the UK’s Travel-to-Work Areas. ISTAT has identified 686 SLLs (ISTAT, 2005), while there are nowadays in Italy 110 provinces (the NUTS3 category) and 20 regions (the NUTS2 category).

² Differences in the economic environment have an important impact upon the banking industry (Berger and Mester, 1997). Hasan et al. (2009) use various control variables to model this impact. However, their environmental proxies are computed at the country level, while the growth estimates are for NUTS2.

³ ‘Alternative profit efficiency’ is a closer representation of reality whenever the assumption of perfect competition is questionable or there are differences of quality/specialization among the firms of the sample. On the other hand, ‘standard profit efficiency’ assumes perfect competition in the markets for inputs and outputs. We choose the ‘alternative profit efficiency’ approach, as also Hasan et al. (2009) do.

⁴ We rely on the routines provided in Belotti et al. (2013) for the estimation of the ‘true fixed-effects model’.

⁵ Before taking logs, a value of 1 is assigned to negative profits and an additional dummy variable is specified, taking value 1 if profits are positive and value 0 if profits are zero or negative.

⁶ Our approach may be sufficiently correct if ‘outside’ banks mainly matter through credit availability (recall that the FV proxy includes the credit offered by all bank branches of a SLL), while local banks are crucial for the qualitative side of financial development. This may happen because, as is often believed in the case of Italy, ‘inside’ banks have a decisive informational advantage in local markets. Faini et al. (1992) provide a classic treatment of the issue.

⁷ Italian CBs must apply the so-called ‘principle of prevalence’, requiring that more than 50% of assets are either loans to cooperative members or risk-free assets, according to the criteria established by the Financial Regulator. Furthermore, as far as profit distribution is concerned, the 1993 law Testo Unico Bancario requires that CBs must: (a) devote at least 70% of annual net profits to legal reserve; (b) pay a share of annual net profits to mutual funds for the promotion and development of cooperation in an amount equal to 3%; (c) devote the remaining share of profits to purposes of charity or mutual aid.

⁸ Particularly, Faini et al. (1992) provide evidence according to which local banks have an advantage over local branches of outside banks in turning their informational advantage into monopoly power. We only compare monopolistic and duopolistic SLLs, partly to draw some comparisons with the loosely similar distinction drawn in Coccorese (2009), and partly because SLLs with more than two bank head offices are likely to be a very heterogeneous group.