Competition and banking efficiency: Are diversification and financial flexibility heterogeneous?

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Abstract

This paper explores the linear and non-linear effect of bank competition on bank efficiency across 110 commercial banks listed in the MENA region over the period 2007–2024 using panel corrected standard error (PCSE) and generalized method of moments (GMM), with robustness checks via difference-in-differences (DID) and logistics regression. This paper fills in the gap of empirical literature by examining the moderating effects of both bank diversification and financial flexibility on the relationship between competition and bank efficiency. This paper used stochastic frontier analysis (SFA) to estimate both cost and profit efficiency. The results uncover a U-shaped link between market power and efficiency, where moderate power initially hinders but eventually enhances efficiency, validating both the quiet life and efficient-structure hypotheses. Market concentration follows an inverted U-shaped curve with efficiency, reinforcing the importance of competition thresholds, with robust checks confirming the findings. The results show that bank diversification strengthens efficiency gains in concentrated markets, in addition to financial flexibility offsets market power inefficiencies and strengthens the benefits of concentration. Ownership concentration helps counteract the downsides of market power and strengthens the efficiency benefits of concentration. Moreover, financial development significantly enhances bank efficiency in competitive environments. Policy implications highlight the need for balanced competition, enhanced financial flexibility, and strategic diversification to sustain banking efficiency.

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