Do more competitive banks have less market power? The evidence from Central and Eastern Europe

• A less concentrated banking market does not always mean higher market power for banks.
• Higher market power for banks is not always related to weak competitive behaviour.
• Almost all CEE banks show an increase in both their competitiveness and market power.
• More competitive banks have less market power for almost all CEE countries.
• Market concentration, market power and competitive behaviour are weakly interrelated.

Studies that have explored the competitive behaviour of banks frequently arrive at divergent conclusions because they use different measures of competition. This study first discusses these various measures of competition and their divergence from a theoretical perspective and then employs them to measure the competitiveness of Central and Eastern European banks and to investigate whether more competitive banks really have less market power. We find that these banks increase their market power when there is low banking concentration and do not necessarily become less competitive. Moreover, a more concentrated banking market does not enhance the market power of banks and does not make them less competitive, and more competitive banks do not necessarily have less market power. This latter outcome ensues because revenue and production reactions to cost evolution are either positively related – or completely unrelated – to the competitive behaviour of banks.