Geographic Diversification and Banks’ Funding Costs

We assess the impact of the geographic expansion of bank assets on the cost of banks’ interest-bearing liabilities. Existing research suggests that expansion can both intensify agency problems that increase funding costs and facilitate risk diversification that decreases funding costs. Using a newly developed identification strategy, we discover that the geographic expansion of banks across U.S. states lowered their funding costs, especially when banks are headquartered in states with lower macroeconomic covariance with the overall U.S. economy. The results are consistent with the view that geographic expansion offers large risk diversification opportunities that reduce funding costs.