Branch banking, economic diversity and bank risk

Abstract

This paper examines the effect of geographic diversity and economic diversity on commercial bank risk. The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 allowed banks to engage in interstate branching starting in June 1997. One of the arguments for allowing banks to branch nationwide is that doing so reduces bank risk by enabling banks to diversify geographically. However, the extent to which geographic diversification reduces risk depends on how economically diverse are the different geographic areas in which banks establish branches. Within the United States each state establishes branching limits, and as a consequence, the degree of branching varies among the states. This paper uses data on the degree of branch banking within states to analyze the impact that branching has on banks’ risk. In addition, for each state a measure of economic diversity is created and used to study the effect of economic diversity on bank risk. The results indicate that economic diversity reduces bank risk and that branching also reduces bank risk.