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Regional economic conditions and the variability of rates of return in commercial banking

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  • Frederick T. Furlong
  • John Krainer

Abstract

We develop new techniques to assess the relationship between commercial bank performance and the economic conditions in the markets in which they operate. In the analysis, we allow for heterogeneity in the responses of banks to regional economic conditions. We find a statistically significant relationship between bank performance and shocks to the regional markets in which they operate. We find that region-specific shocks have a significant and persistent effect on the cross-sectional variance of bank performance in the market. That is, shocks affecting average performance of banks in a region also tend to increase the dispersion of their performance. We demonstrate that this effect is due to heterogeneity in the banks' exposures to their regional economies. Moreover, by allowing for this heterogeneity, we find that systematic responses to regional economic effects are notably more important in explaining the variation in bank performance than suggested by analysis in which responses are constrain to be the same for all banks.

Suggested Citation

  • Frederick T. Furlong & John Krainer, 2007. "Regional economic conditions and the variability of rates of return in commercial banking," Working Paper Series 2007-21, Federal Reserve Bank of San Francisco.
    • Handle: RePEc:fip:fedfwp:2007-21
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    File URL: http://www.frbsf.org/publications/economics/papers/2007/wp07-21bk.pdf
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    References listed on IDEAS

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    1. Donald Morgan & Bertrand Rime & Philip Strahan, 2003. "Bank Integration and State Business Cycles," NBER Working Papers 9704, National Bureau of Economic Research, Inc.
    2. Frederick Furlong, 2004. "Comment on Emmons, Gilbert, and Yeager," Journal of Financial Services Research, Springer;Western Finance Association, vol. 25(2), pages 283-289, April.
    3. Yeager, Timothy J., 2004. "The demise of community banks? Local economic shocks are not to blame," Journal of Banking & Finance, Elsevier, vol. 28(9), pages 2135-2153, September.
    4. Andrew P. Meyer & Timothy J. Yeager, 2001. "Are small rural banks vulnerable to local economic downturns?," Review, Federal Reserve Bank of St. Louis, vol. 83(Mar), pages 25-38.
    5. Andrew M. Cohen & Michael Mazzeo, 2004. "Market structure and competition among retail depository institutions," Finance and Economics Discussion Series 2004-04, Board of Governors of the Federal Reserve System (U.S.).
    6. William Emmons & R. Gilbert & Timothy Yeager, 2004. "Reducing the Risk at Small Community Banks: Is it Size or Geographic Diversification that Matters?," Journal of Financial Services Research, Springer;Western Finance Association, vol. 25(2), pages 259-281, April.
    7. Michelle Clark Neely & David C. Wheelock, 1997. "Why does bank performance vary across states?," Review, Federal Reserve Bank of St. Louis, issue Mar, pages 27-40.
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    Cited by:

    1. Goddard, John & McKillop, Donal & Wilson, John O.S., 2008. "The diversification and financial performance of US credit unions," Journal of Banking & Finance, Elsevier, vol. 32(9), pages 1836-1849, September.
    2. Marco Crocco & Fabiana Santos & Pedro Amaral, 2010. "The Spatial Structure of Financial Development in Brazil," Spatial Economic Analysis, Taylor & Francis Journals, vol. 5(2), pages 181-203.
    3. Albert DePrince & William Ford & Pamela Morris, 2011. "Some causes of interstate differences in community bank performance," Journal of Economics and Finance, Springer;Academy of Economics and Finance, vol. 35(1), pages 22-40, January.
    4. Frederick T. Furlong & John Krainer, 2007. "Regional economic conditions and community bank performance," FRBSF Economic Letter, Federal Reserve Bank of San Francisco, issue jul27.

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    Keywords

    Banks and banking; Bank profits;

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