Leverage and SMEs financial stability: the role of banking competition

This work exploits a large panel dataset on Italian manufacturing SMEs to examine the relationship between leverage and firms’ financial stability. Specifically, we evaluate whether and to what extent this link is affected by the degree of competition characterising the local credit market in which firms operate. Using two measures of local banking competition – the H-statistic and the Boone indicator – our evidence indicates that the negative impact of leverage on firms’ financial health is greater for firms operating in more competitive banking markets. A plausible interpretation of this finding is that the competition drawbacks could prevail on its expected advantages, leading banks to be less inclined to establish lending relationships with risky firms, thus exacerbating their financial vulnerability.