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What drives the persistent competitiveness of small banks?

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  • William F. Bassett
  • Thomas Brady
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    Abstract

    Several trends in the financial industry could have weakened the competitiveness of small banks in recent years. Despite those challenges, small banks have grown more rapidly than larger banks over the period from 1985 to 2001, and their profitability has been sustained at high levels. However, small banks have needed to increase the interest rates offered on deposit accounts in order to attract progressively more deposit funding. In this paper, we provide empirical evidence that this increased interest cost primarily reflects the high rate of return that small banks were able to earn on their assets. Moreover, we show with an arbitrage model that the decline in the real value of deposit insurance has only a small effect on deposit rates as long as bank failure rates are in the low range of recent years.

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    File URL: http://www.federalreserve.gov/pubs/feds/2002/200228/200228abs.html
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    File URL: http://www.federalreserve.gov/pubs/feds/2002/200228/200228pap.pdf
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    Bibliographic Info

    Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2002-28.

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    Date of creation: 2002
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    Handle: RePEc:fip:fedgfe:2002-28

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    Related research

    Keywords: Banks and banking ; Bank mergers;

    References

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    1. James B. Thomson, 2001. "Who benefits from increasing the federal deposit insurance limit?," Economic Commentary, Federal Reserve Bank of Cleveland, issue Sep.
    2. O'Hara, Maureen & Shaw, Wayne, 1990. " Deposit Insurance and Wealth Effects: The Value of Being "Too Big to Fail."," Journal of Finance, American Finance Association, vol. 45(5), pages 1587-1600, December.
    3. Black, Harold A & et al, 1997. "Changes in Market Perception of Riskiness: The Case of Too-Big-to-Fail," Journal of Financial Research, Southern Finance Association & Southwestern Finance Association, vol. 20(3), pages 389-406, Fall.
    4. Leonard I. Nakamura, 1994. "Small borrowers and the survival of the small bank: is mouse bank Mighty or Mickey?," Business Review, Federal Reserve Bank of Philadelphia, issue Nov, pages 3-15.
    5. Steven Pilloff & Stephen Rhoades, 2000. "Do Large, Diversified Banking Organizations Have Competitive Advantages?," Review of Industrial Organization, Springer, vol. 16(3), pages 287-302, May.
    6. Jalal D. Akhavein & Allen N. Berger & David B. Humphrey, 1997. "The effects of megamergers on efficiency and prices: evidence from a bank profit function," Finance and Economics Discussion Series 1997-9, Board of Governors of the Federal Reserve System (U.S.).
    7. Demsetz, Rebecca S & Strahan, Philip E, 1997. "Diversification, Size, and Risk at Bank Holding Companies," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 29(3), pages 300-313, August.
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    Cited by:
    1. Kwangwoo Park & George Pennacchi, 2007. "Harming depositors and helping borrowers: the disparate impact of bank consolidation," Working Paper 0704, Federal Reserve Bank of Cleveland.
    2. Becker, Bo, 2007. "Geographical segmentation of US capital markets," Journal of Financial Economics, Elsevier, vol. 85(1), pages 151-178, July.

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