Event-Study Evidence of the Value of Relaxing Longstanding Regulatory Restraints on Banks, 1970-2000

Abstract

In a partial-equilibrium model, removing a binding constraint creates value. However, in general equilibrium, the stakes of other parties in maintaining the constraint must be examined. In financial deregulation, the fear is that expanding the scope and geographic reach of very large institutions might unblock opportunities to build market power from informational advantages and size-related safety-net subsidies.This paper reviews and extends event-study evidence about the distribution of the benefits and costs of relaxing longstanding geographic and product-line restrictions on U.S. financial institutions. The evidence indicates that the new financial freedoms may have redistributed rather than created value.Event returns are positive for some sectors of the financial industry and negative for others. Perhaps surprisingly, where customer event returns have been investigated, they prove negative. In 1970, commercial banks could be distinguished from other kinds of financial institutions by two unique capacities: their right to offer demand deposits and their ability to make commercial loans. Restrictions on thrift, securities, insurance, and sales-finance companies made it hard for these and other kinds of nonbank institutions to offer close substitutes for banking's signature products.This paper seeks to clarify how and why technological change undermined and finally demolished geographic and product-line constraints on U.S. financial institutions and to review event-study evidence about the intersectoral distribution of the benefits and costs of relaxing particular restrictions. The evidence indicates that the demolition of these restraints intensifies public-policy concerns about the extent to which market power may be generated by large-bank mergers and safety-net subsidies that increase as an institution reaches megasize and megacomplexity.

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