Banking Competition in Central and Eastern European Loan Markets: An Empirical Estimation Kalle Ahi Tallinn University of Technology Ehitajate tee 5, 19086 Tallinn Phone: +372620 4061, e-mail: kalle.ahi@ttu.ee Abstract In the current study we attempt to evaluate the level of competition in the banking industries of nineteen Central and Eastern European (CEE) countries. Specifically, we use a novel non- structural approach for identification of banking competition, the method first introduced by Boone (2008) and apply it to loan markets of CEE countries over the period 2003-2010. Our results indicate that, although countries exhibit a large variation in competitive conditions, generally the level of competition in CEE countries has decreased. Major changes in the level of competition can be associated with the onset of financial crisis. JEL Classification: D4, G21, L1 Keywords: banking industry, competition, translog cost function, Boone indicator, CEE countries 1. Introduction Banks mobilize, allocate, and invest much of society’s savings; hence, bank performance has a substantive impact on capital allocation, industrial expansion, financial stability, and economic development. Thus, the factors that affect how efficiently a banking system carries out these tasks are of major concern to the research. Recent research assigns an increasingly important role to the level of competition among banks as a substantial determinant of the overall efficiency of financial intermediation and the evolution of financially sound capital markets (see for example Yanelle, 1997; Berger et al., 2004 and more recently Carbo et al., 2009 for a review of the literature). The CEE banking markets have undergone great changes due to major structural reforms in these countries and immense changes in their banking systems. Besides the shifts in political regime, the transition in these countries has occurred as a result of deepened monetary and financial integration, as well as deregulation of the domestic financial system and liberalization of capital flows. Banks play a dominant role in CEE countries as major provider of credit, participant in the payment systems and as agents of monetary policy transmission. Thus any market failure, anticompetitive conduct or inefficiencies could have serious repercussions throughout the whole economies. Moreover, CEE banking markets have experienced a trend of consolidation as a series of mergers and acquisitions were undertaken mainly by foreign banks, leading to more concentrated markets and substantially reshaping not only the structure of banking but financial sectors as a whole. Theoretically it’s not clear if high level of competition in the banking sector is necessarily welfare enhancing as suggested by traditional industrial organisation literature. Specific to the banking sector is the potential negative trade-off between competition and