Research

We estimate the effects of bank competition on economic development relying on a merger episode that involved the two largest banks competing over small firms in Peru. By exploiting differences in the banks’ geographical footprint, we measure how the merger changed the degree of competition in local banking markets, and how it affected credit, economic activity, and the allocation of resources across firms. We find an aggregate decline in credit, labor, capital, and sales of small firms after the merger. Moreover, we find that low bank competition discourages entry decisions, favoring incumbent firms over potential entrants, and reducing business dynamism. The decline in bank competition has substantial distributional effects. The contraction of capital is concentrated among small firms with high marginal returns, which increases capital misallocation. In equilibrium, large firms expand by taking over the market share previously attended by small firms, leading to higher levels of concentration in the real economy.