Bank cost efficiency and underground economy: The asymmetric impact of cooperative and non-cooperative banks

We build a model of firms' choice between regular and irregular labor factors which links the cost efficiency of banks to the size of the underground economy. We consider two kinds of credit institutions supplying loans to the firms, cooperative and non-cooperative banks. The theoretical results show that cost-efficiency encourages firms to hire more regular workers. We then test our theoretical predictions using regional data for Italy over the 2004–2017 and assess how the efficiency of cooperative and non-cooperative banks, shapes the underground economy. In line with our theoretical prediction, increased cost efficiency reduces the size of the underground economy, especially in building and agriculture, and the estimated coefficients for the different types of banks are quite similar in size. Our evidence is robust to banks’ size, once we control for the likely simultaneity between cost efficiency and the underground economy and once we include the quality of institutions.