How Banking Deregulation Affects Growth: Evidence from a Panel of U.S. States

Abstract

This paper examines the impact of banking deregulation on growth in the U.S. Many states relaxed restrictions on intra-state bank branching beginning in the early 1960s, both by allowing bank holding companies to convert subsidiaries into branches and by permitting statewide de novo branching. This increased competition in the banking sector forced financial intermediaries to become more efficient. The existing literature suggests that one of the channels through which this worked was bank lending. Different industries have varying degrees of dependence on external financing, and industries that are more dependent on external financing should grow faster in the post-deregulation period. While this issue had been partly examined in a broader cross-country setting, it had not been hitherto explored for the U.S. In a panel data set, I find this not to be the case for the U.S.; industries that borrow less from banks in fact grew at a faster rate after deregulation. This could be the result of commercial banks losing market share to other sources of external financing, the general decline in the U.S. manufacturing sector and the terms of trade moving in favor of agriculture. I also consider the effect of deregulation on various measures of bank performance and find the strongest impact to be on the number of commercial banks operating in the state. Contrary to existing research, these regulatory changes slowed down growth in the number of bank branches and offices, as well as other measures of bank performance like assets, equity, loans and deposits. This suggests that the gains from deregulation are short-lived, and also reflect unprofitable smaller banks shuttering their operations and the emergence of credit unions and other alternatives to commercial banks.