Essays on local banking markets

The financial system executes the pivotal economic function of facilitating the flow of funds from those with surplus funds to those with a lack of funds. Funds can be transferred directly via financial markets through issuance and trading of securities which are claims on the borrower’s future income or assets (market-based finance) or indirectly via banks and other credit institutions (bank-based finance).
A large strand of literature is devoted to address the question whether the design of the financial system matters for economic growth. Some economists do not consider the role of finance in economic growth to be important. Other economists, following the influential work by Schumpeter (1911), strongly believe that one of the crucial aspects of a well-developed financial system is an effective allocation of funds that fosters economic performance.
Given contradictory evidence the aim of this dissertation is to contribute to the literature on the financial development by providing an analysis on local banking markets, their determinants and the role in economy. Given the above considerations, I start with an investigation of the role of local banking markets itself for economic perspectives. More specifically, Chapter 1 is devoted to the importance of local banking market development on firms’ conduct of R&D. Using a unique data set and employing an instrumental variable (IV) approach which uses historical and legal features of the strongly regionally oriented German banking system, our results suggest no or even a negative relationship between the development of a local banking system and the R&D activities of firms located in that regions. This applies to both the extensive and intensive margin.
In Chapter 2, another characteristic of local banking markets is exploited. Namely, the paper investigates whether more or less concentration on local banking markets is better for regional growth. The former is measured by the Herfindahl-Hirschman concentration index (HHI) whereas the latter is represented by the macro- as well as micro-level variables. Whereas the obtained results do not find any significant effect for East Germany the empirical evidence suggests that more vigorous banking competition in the West German banking markets that is associated with lower value of the HHI at NUTS 3 level increases labor productivity and unemployment rate as a result of more effective employers. Better banking competition also promotes firm creation while stronger concentration in regional banking markets is beneficial for firms population and their size.
Chapter 3 presents a study with the focus on the effect of public debt on local banking market development in Germany. The provided analysis is distinctive in several aspects. First, the role of government borrowing for banking market development still remains underappreciated in empirical literature although its essential importance is unequivocal according to theory. Second, in comparison to other studies that mostly provide a cross-country investigation I analyze an intranational heterogeneity in the degree of financial development and public debt. Third, to the best of my knowledge this is the first study examining the determinants of financial development for Germany. The obtained results reveal an adverse effect of more government debt on local banking market development.