Geographic deregulation and commercial bank performance in U.S. state banking markets

Abstract

This paper examines the effects of geographical deregulation on commercial bank performance across states. We reach some general conclusions. First, the process of deregulation on an intrastate and interstate basis generally improves bank profitability and performance. Second, the macroeconomic variables -the unemployment rate and real personal income per capita -and the average interest rate affect bank performance as much, or more, than the process of deregulation. Finally, while deregulation toward full interstate banking and branching may produce more efficient banks and a healthier banking system, we find mixed results on this issue. Journal of Economic Literature Classification: E5, G2Keywords: commercial banks, geographic deregulation, bank performance Geographic Deregulation and Commercial Bank Performance in US State Banking Markets IntroductionThis paper examines the effects of geographical deregulation of banking and branching activity on commercial bank performance across states. In this paper, we test whether Riegle-Neal and the process of deregulation that proceeded its passage allowed banks to achieve greater efficiency and profitability. We examine the profitability of the U.S. commercial banking industry before and after Riegle-Neal on a state-by- Literature ReviewDuring the past thirty years, competition in banking and attempts to expand market reach by large Defining the "relevant" market at the state level, rather than at the MSA and non-MSA county levels, as is common in the literature, they test whether consolidation in the banking industry improves profitability and performance by lowering costs or increasing market power. They perform two different tests of this issue. First, they consider the relationship between several measures of bank concentration and one measure of bank efficiency at the state level and the performance of the average bank within that state. They find a robust and significant positive correlation between bank concentration in a state and the return on equity of the average bank in that state and a significant negative correlation between bank efficiency in a state and the return on equity of the average bank in that state. This last effect proves significant, however, only when they exclude the unemployment rate. Second, they perform Granger temporal causality tests between bank performance and market power, finding that market power temporally leads bank performance. This finding supports the market power over the efficient structure hypotheses of improved bank performance. Based on their two different tests, they conclude that the marketpower rather than the efficient-structure theory receives more support.Berger and Mester (2003) and Berger, Demsetz, and Strahan (1999) report evidence on this issue as well. They argue that rising profitability during the 1990s primarily reflects higher revenue, since costs also rise. Moreover, they attribute this rising profitability to merger activity. They contend that the initial providers of better service provision...

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