An Empirical and Theoretical Analysis of the Relationship Between Bank Market Power and Innovation in Nigeria

The relationship between bank market power and financial innovation is theoretically ambiguous: market power may generate innovation-funding capacity but simultaneously reduce competitive pressure to innovate, and resolving this tension with Nigerian evidence constitutes an important original contribution. This study develops an original theoretical model of the market power-innovation relationship in Nigerian banking, integrating Schumpeterian innovation theory, the quiet life hypothesis, and the innovation-competition literature into a unified framework that accounts for the institutional characteristics of Nigerian banking markets. The model formally derives conditions under which market power either stimulates or suppresses financial innovation, generating testable non-linear predictions. Empirically, a bank-level panel dataset was constructed for eighteen commercial banks from 2009 to 2022, with innovation measured by a composite index of new product launches, digital channel investment intensity, and patent and trademark filings. Market power was measured by the Lerner index. System generalised method of moments with instrument validity tested through Hansen and Arellano-Bond diagnostics was employed. Results reveal an inverted U-shaped relationship between market power and innovation (quadratic Lerner index coefficient = -0.042, p < 0.01), confirming the theoretical model's non-linearity prediction. Moderate market power (Lerner index between 0.25 and 0.45) is associated with peak innovation activity. Banks beyond this range innovate significantly less. The study makes original contributions to the Nigerian banking innovation literature by formally modelling and empirically confirming non-linear market power-innovation dynamics, with implications for competition policy design in the banking sector. Keywords: bank market power, financial innovation, Lerner index, Schumpeterian theory, Nigerian banking