the institutional environment is contestable. Institutional arrangements for an effective competition policy in the banking sector call for a clear separation from prudential oversight to avoid potential conflicts of interest, and for better coordination of competition policy functions. In this section, we present results in which we add to the baseline specification an interaction between a proxy for competition policy and institutional effectiveness, and external finance dependence. Results are shown in Tables 10 – 13. Each table reports results obtained by adding a series of policy variables to the baseline specification with the 5‐bank concentration ratio, 3‐ bank concentration ratio, the Boone indicator and the Lerner index, respectively.

We first test whether direct government intervention in credit markets via state‐owned banks exacerbates the negative impact of low bank competition on economic growth of financially dependent firms. The academic literature supports the negative view of public ownership, indicating that the presence of state‐owned banks leads to an unleveled playing field and hence less competition (See Barth et al., 2004; and La Porta et al., 2002). State‐owned banks enjoy privileges and immunities that are not available to their privately‐owned competitors, giving them an unfair competitive advantage over their rivals. Moreover, firms borrowing from state‐ owned banks may pay less than firms borrowing from privately‐owned banks but tend also to be less profitable and riskier on average (Sapienza, 2004). In our analysis, government ownership is the share of the banking system’s total assets held by banks that are 50 percent or more state‐ owned, based on information collected from regulatory agencies (see Barth et al., 2013). The interaction between government ownership and external finance dependence should enter our baseline specification with a negative sign. Results are reported in the first column in each table (labeled “Public assets”). In all specifications, we do not find a significant effect of direct government intervention in the banking sector.

Next, we assess whether increased foreign bank penetration is associated with higher growth of industries whose firms depend heavily on external sources of finance. Foreign bank entry may enhance competition in domestic banking markets, improve the efficiency of domestic bank operations, provide financial services at lower costs, and ultimately promote economic growth (Claessens et al., 2001; Claessens and Laeven, 2004; Martinez‐Peria and Mody, 2004; Levy‐Yeyati and Micco, 2007; Mirzaei and Moore, 2014). On the other hand, foreign banks may cherry‐pick high quality (low default risk) borrowers (Dell’Ariccia and Marquez, 2004 and Sengupta, 2007) and adversely affect both domestic banks and the firms that rely upon them (Detragiache et al., 2008). The sign of the interaction of our measure of foreign bank penetration, i.e. share of total bank assets in foreign‐owned banks (Barth et al., 2013), with our index of external finance dependency is therefore unclear. Results are reported in column 2 (labeled “FX assets”). The estimated coefficient is always negative, but statistically significant only in the specification with the 5‐bank ratio. Though evidence is only suggestive, the negative sign favors the latter channel, with foreign bank penetration affecting negatively growth in financially dependent sectors.

The degree of competition in banking depends crucially on entry barriers. Regulators in most countries do not allow just anyone to enter the banking system, but rather screen entrants to better assure they are “fit and proper.” By imposing certain basic requirements before a banking license is accepted or rejected, those allowed to enter may be of higher quality and thereby 11