Estimating the Market Power of Banks in the EU: A Stochastic Frontier Approach with Environmental Variables

Abstract

This paper aims to measure market power in the EU banking system, controlling for the influence that environmental conditions, such as monetary policy or bank capital regulation, may have on banks’ performance. An empirical analysis is carried out using stochastic frontier methods and an unbalanced panel of 756 EU commercial, cooperative, and savings banks for the period 2005–2019. The estimation results reveal that including contextual variables leveled down the mean Lerner index estimates for the whole sample of banks. Furthermore, the research findings show the existence of systematic differences between EMU and non-EMU banks, with significantly higher market power levels for non-EMU banks as a group. These results also suggest growing disparities in market power among EMU banks since 2014, which may be explained by the existence of persistent barriers to integration within the EU banking market.