Bank market power, factor reallocation, and aggregate growth

• Decomposing aggregate growth into input growth, technical change and reallocation.
• Bank markups spur aggregate SME growth through technical change.
• Banks with more market power foster the reallocation of resources.
• Banks seem to need sufficient markups to allocate financial funds efficiently.

Using a unique firm-level sample of approximately 700,000 firm-year observations of German small and medium-sized enterprises (SMEs), this study seeks to identify the effect of bank market power on aggregate growth components. We test for a pre-crisis sample whether bank market power spurs or hinders the reallocation of resources across informationally opaque firms. Identification relies on the dependence on external finance in each industry and the regional demarcation of regional banking markets in Germany. The results show that bank markups spur aggregate SME growth, primarily through technical change and the reallocation of resources. Banks seem to need sufficient markups to generate the necessary private information to allocate financial funds efficiently.