Using a sample of 23 manufacturing sectors during the period 2002‐2010, we provide evidence on the extent to which competition in the GCC banking systems affects economic growth of financially dependent industries. We do so by using a panel data specification of the empirical setup developed by Rajan and Zingales (1998) to study the effects of financial development on growth, and adapted by Cetorelli and Gambera (2001), Claessens and Laeven (2005), Fernandez de Guevara and Maudos (2011) and Liu et al. (2014), among others, to assess the relationship between banking system competition and value added growth of financially dependent industries. The use of panel data follows Dell’Ariccia et al. (2008), who study the effect of banking crises on financially dependent industrial sectors. In our context, panel data are preferred to cross‐section regressions as in, e.g., Rajan and Zingales (1998), because of the limited number of observations in our sample, i.e. industry‐country data for GCC economies, as well as by the need to account for time‐variation in bank competition.

We then generalize our baseline framework in several directions to address a number of potential criticisms, which would apply to ours as well as to any similar study. First, to avoid a possible bias in our policy conclusions originating from the measure of bank competition employed, we use both structural indicators (five‐ and three—bank concentration ratio) and direct measures of market power (Lerner index and Boone indicator). Second, to avoid potential misspecification bias due to a potential nonlinear relationship between the degree of competition in the banking sector and real activity, as highlighted in the theoretical and the empirical literature on banking crises (see Martinez‐Miera and Repullo, 2010, and Beck et al., 2013, respectively), we test for the presence of nonlinearities by adding squared terms of our measures of bank market power. Third, since the baseline results can be driven by the way we measure financial dependence, we use alternative indicators developed in the literature, i.e., Rajan and Zingales (1998), Klapper, Laeven and Rajan (2006) and Fernandez de Guevara and Maudos (2008), and we control for the average size of firms. Finally, we address the question of what effects different competition‐ related public policies might have on industry growth.

Our main findings can be summarized as follows. First, industries that are more dependent on external finance experience higher growth performance if competition in the banking sector is higher. This result holds true when both structural and direct indicators of market power are employed. Second, the impact of bank competition on growth is unambiguous, i.e., it does not depend on the degree of competition: the relationship is linear. Third, we find that our results are robust to alternative measures of financial dependence and that sectors dominated by small‐ scale firms suffer more when the banking sector is less competitive, which we interpret as further evidence in support of the baseline result. Fourth, we find that relaxing restrictions on banks’ activities, improving the credit information environment and implementing an effective competition law play an important role in fostering growth in sectors that depend on external finance.

The paper is organized as follows. Section 2 describes the data used in the empirical analysis. In Section 3 the empirical methodology is discussed. Section 4 presents the results. Section 5 examines the role played by different competition policies and institutional arrangements. Section 6 concludes and draws some policy implications.

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