Diversity in banking: How does competition in the Italian banking market affect bank performance?

This study examines the theoretical and empirical effects of market competition on bank performance through the lens of institutional diversity (i.e., considering different types of credit institutions interacting in the credit market). In terms of the theoretical framework, interactions between banks are modelled as mixed Cournot competition with strategic interactions between representatives of the same and different categories. Using ABI's BilBank 2000 database and fixed effects estimates, the empirical study investigates the competition-performance nexus in Italy from 1994 to 2015. Theoretical prediction suggests that diversity in less concentrated markets can improve bank performance. The empirical results confirm the theoretical expectation, suggesting that a less concentrated financial system, characterised by a constellation of credit institutions with a high degree of differentiation in ownership structure and objective functions, improves bank performance. Policy makers and regulators should encourage greater competition in the banking market to improve bank performance in a diversified financial environment.