The Sensitivity of Bank Performance to Local Housing Prices - Evidence from Diversified and Local Banks

Abstract

This paper investigates the performance sensitivity of geographically diversified and non-diversified banks to local housing prices in the United States. We find that despite enduring the limitation of risk diversification, local banks experience a lower performance sensitivity to housing prices than their diversified counterparts. The difference in sensitivity between the two types of banks is pronounced in bear (but not in bull) housing markets. Further analysis shows that local banks better manage their loan quality, and diversified banks encourage more risk taking. The findings are robust to addressing the endogeneity problems of local housing markets and geographic diversification strategy of banks. Taken together, our findings highlight the local advantage of non-diversified banks and explain why they coexistent with diversified banks even after the consolidation waves following bank deregulation.