Secuencia Didáctica

From the end of the Great Depression, which caused thousands of bank defaults, until the early 1970s, most states in the U.S. imposed restrictions on statewide branching (either full “unit banking” or partial “limited branching”) ostensibly to protect local and small banks from the threat of competition from large banks. In addition to the intrastate (statewide) branching restriction, the Douglas Amendment to the 1956 Bank Holding Company Act prohibited a BHC from acquiring banks outside the state where it was headquartered unless the target bank’s state permitted such actions. Though the states could allow out-of-state BHCs to enter, all states chose to prohibit the interstate bank expansion until 1978 when Maine became the first to allow acquisitions of its in-state banks by out-of-state BHCs. During the next two decades (the 1970s and 1980s), many states relaxed the restrictions on intrastate branching and interstate banking activities. By 1993, only Arkansas and Iowa still DID not fully allow intrastate branching activities, and only Hawaii still prohibited interstate banking activities.43 The next and final era of deregulation on bank geographic expansion started in 1994 when the U.S. government

43 _{Arkansas lifted fully the interstate branching restriction in 1994 and Iowa in 1999. Hawaii allowed}

interstate banking activities in 1997. See Kroszner and Strahan (1999) and Francis, Hasan, and Wang (2014) for more details on the timing of the intrastate branching and the interstate banking deregulation.

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passed the Riegle-Neal IBBEA. The Riegle-Niel Act allowed unrestricted interstate banking (effective in 1995) and legalized interstate branching in all U.S. states (effective in 1997).44 After this law was enacted, banks or BHCs could either open new branches in other states or convert their subsidiaries in other states into operational branches. Therefore, this deregulation is mainly a more advanced step of the interstate banking deregulation.

A few papers have studied the impact of the geographic expansion deregulation on bank risk and the empirical results found are mixed. Jayaratne and Strahan (1996) study state-level data of all commercial banks from 1976 to 1992 and find that the intrastate branching deregulation is associated with lower credit risk. Using the same state-level data, Jayaratne and Strahan (1998) find similar results for the interstate banking deregulation, but to a lesser extent than the impact of the intrastate branching deregulation. Rose (1996) examines a sample of 84 large U.S. BHCs from 1980–1992 and find some evidence that interstate banking expansion leads to higher risk. However, Rose shows that some diversification gains emerge when banks expand to at least four states. Rivard and Thomas (1997) study 218 BHCs’ data from 1988–1991 and find that interstate BHCs have higher profitability, lower earnings volatility, and lower insolvency risk compared to strictly intrastate banks. Carlson and Mitchener (2006) examine earlier state-level national banks’ data from 1922–1930 (the Great Depression era) and find that intrastate branching activities lead to tougher competition, which results in improvement of the banking system stability by removing weak and inefficient banks. Dick (2006) study the impacts of the Riegle-Niel interstate branching deregulation from 1993–1999

44 _{However, the law permitted the states to take advantage of several provisions to slow down the growth of}

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and finds that the deregulation leads to higher credit portfolio risk. Subramanian and Yadav (2012) examine the impact of the intrastate branching and the interstate banking deregulation on bank failures from 1976–1994. They find that intrastate branching deregulation leads to fewer bank failures (especially in the unit banking states) due to more portfolio diversification, operating efficiencies, and reduced loan losses. However, they find no evidence that interstate banking deregulation affects bank failures. Goetz, Laeven, and Levine (2016) develop a new instrument to identify exogenous sources of variation in geographic diversity at the BHC level and use it to examine the impact of BHC geographic expansion (in response to interstate banking deregulation) on BHC risk. Using the data of listed BHCs from 1986:Q2-1997:Q4, they find that BHC geographic expansion is associated with lower BHC risk. However, BHC geographic diversification has no significant impact on BHC loan quality.

Theoretically, there are at least three channels through which geographic deregulation may increase risk and at least two channels through which risk may reduce, making the net effect an empirical question. Turning to the first risk-increasing channel,

the Hubris Channel, deregulation provides opportunities for bank managers to expand their businesses geographically and gain higher salaries and/or more resources under their control to extract for their private benefits (e.g. Jensen, 1986; Berger and Ofek, 1995; Servaes, 1996; Denis, Denis, and Sarin, 1997; Laeven and Levine, 2007, Berger, El Ghoul, Guedhami, and Roman, forthcoming). Under the Diversification Monitoring Channel, the geographic diversification raises more difficulty for the banks in monitoring their loans and managing their risks because of both increased complexity and distances between branches or subsidiaries (e.g. Winton, 1999; Berger and DeYoung, 2001;

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Brickley, Linck, and Smith, 2003; Berger, Miller, Petersen, Rajan, and Stein, 2005). Finally, under the traditional Competition-Fragility Channel, bank deregulation that leads to more competition in the local market, which may increase bank risk. Specifically, tougher competition erodes banks’ profit margins and results in reduced franchise values, reducing incentives for the banks to control their risks to protect these values (e.g. Keeley, 1990; Hellmann, Murdock, and Stiglitz, 2000; Repullo, 2004).

Under the first risk-reducing channels, under the Diversification-Stability Channel, bank deregulation provides an opportunity for banks to diversify their assets and widen their depositor bases, thereby reducing bank risk (e.g. Gart, 1994; Hubbard, 1994; Meslier-Crouzille, Morgan, Samolyk, and Tarazi, 2015; Goetz, Laeven, and Levine, 2016). Such diversification is an important part of the risk-transformation function of banks under modern portfolio theory (e.g., Diamond, 1984; Boyd and Prescott, 1986). Under the second risk-reduction channel, the Competition-Stability Channel, bank deregulation intensifies competition in local markets (e.g. Jayaratne and Strahan, 1996; Carlson and Mitchener, 2006; Kerr and Nanda, 2009; Beck, Levine, and Levkov, 2010). More competition in the loan market reduces loan interest rates, which reduces borrower moral hazard and adverse selection problems (e.g. Boyd and De Nicolo, 2005; Boyd, De Nicolo, and Jalal, 2006; Akins, Li, Ng, and Rusticus, 2016).

4.3 DATA, VARIABLES, AND SUMMARY STATISTICS