industry and employ alternative measures based on the observation of the conduct of firms in the market such as the Lerner index, the Boone indicator or the Panzar‐Rosse H‐statistic. There is some evidence that market concentration is not a good proxy of bank competition (Claessens and Laeven, 2004; Carbo‐Valverde et al., 2009), and therefore policy implications may be sensitive to the measure of competition employed. Along these lines, Claessens and Laeven (2005) find support for the _market power hypothesis_ in a sample of 16 economies, showing that sectors heavily reliant on external financing grow faster where there is fierce competition. Liu et al. (2014) confirm this finding for a sample of 48 countries. Love and Martinez‐Peria (2014) also find that bank market power reduces access to finance for a cross‐section of firms across 53 countries, mainly developing economies. Leon (2015) and Ryan et al. (2014) reach similar conclusions in favor of the _market power hypothesis_ , for a sample of developing countries and 20 European countries, respectively. Fernandez de Guevara and Maudos (2011) find opposing evidence that the exercise of market power enhances the growth of financially dependent firms in for a sample 53 sectors in 21 countries, in line with the _information hypothesis_ . Hoxha (2013) provides similar findings.

This paper investigates the impact of bank competition on external financing constraints in the countries of the Gulf Cooperation Council (GCC). While displaying some significant differences in terms of size and population, the GCC countries (Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates) all share high dependence on the hydrocarbon sectors and a long‐term policy objective to diversify their economic structures. Financial sector development is as important for economic growth for resource‐based economies as for other countries (Beck, 2011). The financial sector in the GCC is dominated by banks and is as deep as that of many advanced economies. Yet it falls short of providing access to finance for the large majority of its firms, especially SMEs. Available credit tends to be heavily concentrated, favoring a few large and well‐established firms (Rocha et al., 2011). The share of SME lending is about 2 percent and has hardly improved in recent years.

There is evidence that the GCC banking sectors operate under monopolistic competition. Both structural indicators and direct measures of bank market power indicate that GCC banking systems are among the least competitive in the world (Al‐Muharrami et al., 2006; Anzoategui et al., 2010), with a large presence of domestic players and state‐owned banks (Al‐Hassan et al., 2010). This is largely explained by stringent licensing requirements, weak credit information environment, low presence of non‐bank financial institutions and relatively shallow capital markets (Anzoategui et al., 2010). The lack of foreign bank competition and the inability of banks to engage in non‐traditional banking activities due to activity restrictions also contribute to explain the low degree of competition in the GCC banking systems (Al‐Muharrami et al., 2006).

A competitive banking sector may, therefore, play a pivotal role in the GCC strategy of economic diversification and increased firm access to finance. The development of the non‐oil industrial sector is key to economic diversification and it can be expected that those sectors that are more reliant on external finance will benefit more if the degree of bank competition in the region is increased. This paper tests this hypothesis thus contributing to the ongoing academic and policy debate on the effect of bank competition on firm access to finance and growth.

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