The Effect of Bank Deregulation on Small Business: A Note

Abstract

THE PROCESS OF BANK deregulation has been greatly aided by the recent decisions of several states to liberalize their branching and holding company codes. Some states which previously had strict unit banking codes have begun to allow multibank holding company formation while other states which had previously limited branching to a single county now often allow branching throughout the state. The final result of this process is nationwide banking which has not yet been approved by Congress. As bank structure restrictions are relaxed, there is a tendency for larger banks to expand, at least in part, through the acquisition of smaller banking institutions. This naturally reduces the number of independent banking organizations in states where such acquisitions occur. Such consolidation undoubtedly results in many of the hypothesized advantages of deregulation, such as more efficient operation due to scale economies. However, it is also possible that it has imposed costs upon some existing customers, at least in the short term. Small businesses may well be among those customers who suffer as a result of bank consolidation. Prior research suggests that variations in banking structure primarily affect the credit conditions of small businesses more than those for larger businesses. Studies by Eisenbeis [1], Jacobs [3], and Meyer [4] provide support for the hypothesis that increased market concentration leads to higher loan rates for small business firms. Moreover, to the extent that the expansion of branch banking is associated with higher levels of concentration, the cost of small business credit could be adversely influenced. This possibility is important since the small business sector is a vital segment of the economy not only from an employment and production perspective, but also from a financial one.' A recent estimate of commercial bank business lending by the Interagency Taskforce on Small Business Finance [2] indicates smallbusiness loans account for about one-third of the approximately $360 billion total. Banks with assets less than $1 billion extended close to four-fifths of the business loans outstanding to small business.