No abstract

The literature is divided on the expected effects of increased competition and consolidation in the financial sector on the supply of credit to relationship borrowers. This paper tests whether policy changes fostering competition and consolidation in U.S. banking helped or harmed entrepreneurs. We find that the rate of new incorporations increases following deregulation of branching restrictions, and that deregulation reduces the negative effect of concentration on new incorporations. We also find the formation of new incorporations increases as the share of small banks decreases, suggesting that diversification benefits of size outweigh the possible comparative advantage small banks may have in forging relationships.OVER THE PAST TWO DECADES, the U.S. financial sector has been reshaped by rapid technological innovation and deregulation. In the 1970s, traditional financial intermediaries, mainly banks, provided the lion's share of credit to nonfinancial companies. At that time, banks had the advantage because they were protected from competitive pressures; price competition was limited by Regulation Q, and entry into banking markets was limited by restrictions on in-state branching and interstate banking.All of this changed over the past 25 years. Starting in the latter half of the 1970s, the U.S. banking system began to be reshaped, both by technological innovations and by the removal of many of these constraining regulations. In the early 1980s, for example, interest rate ceilings were largely removed, allowing banks to compete more vigorously for funds. New technologies like the automated teller machine also enhanced competition within banking, and innovations such as the cash management account offered by nonbank financial companies enhanced competitive pressures from outside the industry. By the end of the 1980s, banks had lost substantial ground to nonbank financial institutions and capital markets; commercial paper and bonds, for example, now exceed bank loans in importance~Figure 1!.During the same period, restrictions on banks' ability to expand into new markets were lifted by state-level legislative initiatives allowing both branching across the state and allowing interstate banking-that is, cross-state

Legal and institutional differences shape the ownership and terms of bank loans across the world. We show that under strong creditor protection, loans have more concentrated ownership, longer maturities, and lower interest rates. Moreover, the impact of creditor rights on loans depends on borrower characteristics such as the size and tangibility of assets. Foreign banks appear especially sensitive to the legal and institutional environment, with their ownership declining relative to domestic banks as creditor protection falls. Our multidimensional empirical model paints a more complete picture of how financial contracts respond to the legal and institutional environment than existing studies. Copyright 2007 by The American Finance Association.