Access to Finance, Banking Market Power and Institutional Development

I investigate effect of banking market power, assumed to increase in market concentration, on firms'' financing constraints in a number of countries in 1991–2002. I find evidence for financing constraints indicated by sensitivity of firms'' investment to availability of internal finance. Results show that banking concentration reduces firms'' constraints. Small firms are constrained & become less so in more concentrated markets. There is no evidence for constraints for large firms or for effect of concentration on sensitivity of their investment to availability of internal funds. I find that legal system efficiency, financial development & level of restrictiveness of regulatory environment can each indirectly influence investment through its impact on banking concentration. None of these factors directly affects investment. I find evidence for differential effect of concentration on firms'' constraints in countries with different levels of institutional development. Results show that beneficial effect of banking market power on access to credit may be limited for certain types of borrowers & delivered under certain policy conditions.