Bank Expansion after the Riegle-Neal Act: The Role of Diversification of Geographic Risk
The Riegle-Neal Act in 1994 established the conditions for the removal of restrictions on interstate banking and branching in US. One of the primary motivations for enacting this act was permitting banks to diversify geographic risk. The purpose of this paper is to study the role of diversification of geographic risk as one of the motives for bank expansion during the period 1994-2006. We propose and estimate a game theoretic model of banks' decisions to operate branches in local markets. A key feature of the model is that a bank's decision of where to operate branches is modeled as a portfolio choice between risky assets. The returns to a bank's investments in a local geographic market (e.g., loans to local business and households) have a risk component that is specific of the local market. A bank is concerned with both the aggregate expected return and the aggregate risk of its portfolio of geographic markets. To estimate this model, we construct a data set that combines information from four different sources: branch and deposits data from the FDIC database; information on mergers/acquisitions from the Chicago Fed; a detailed and comprehensive description of the timing of adoption of the Riegle-Neal Act in different states; and Census Bureau county-level data on population, income and industry composition.
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