Strahan - The Real Effects of U.S Banking Deregulation...

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The Real Effects of U.S. Banking Deregulation Philip E. Strahan JULY/AUGUST 2003 111 I n the 1970s, commercial banks in the United States faced restrictions on interest rates, both on the deposit and lending sides of their busi- ness. They were restricted for the most part to classic financial intermediation—deposit-taking and lending—to the exclusion, for example, of underwriting many corporate securities and insur- ance products. And banks were limited in the geographical scope of their operations. No state permitted banks headquartered in other states either to open branches or to buy their banks, and many states prohibited or restricted intrastate branching. Today, almost all of these restrictions have been lifted: Interest rate ceilings on deposits were phased out in the early 1980s; state usury laws have been weakened because banks may now lend anywhere; and limits to banks’ ability to engage in other finan- cial activities have been almost completely elimi- nated, as have restrictions on the geographical scope of banking. As a result, our banking system is now more competitive and more consolidated than ever— both vertically and horizontally. This paper focuses on how one dimension of this broad-based deregulation—the removal of limits on bank entry and expansion—affected economic performance. In a nutshell, the results suggest that this regulatory change was followed by better per- formance of the real economy. State economies grew faster and had higher rates of new business forma- tion after this deregulation. At the same time, macro- economic stability improved. By opening up markets and allowing the banking system to integrate across the nation, deregulation made local economies less sensitive to the fortunes of their local banks. First, I explain how relaxation of geographical restrictions on bank expansion proceeded histori- cally and why our somewhat unusual history of state-level regulation and deregulation presents an attractive setting to study how the financial system affects the real economy. I then present evidence that banking deregulation led to substantial and beneficial real effects on our economy. The findings are important for at least two reasons. First, they demonstrate the tight link between “Wall Street” and “Main Street.” Finance is not only affected by the fortunes of the industrial sector, but the reverse holds true as well. This mutual dependence high- lights the importance of financial regulation not only here in the United States but, perhaps even more critically, in emerging economies without a well- developed set of financial markets and institutions. Second, the results support the idea that competition and openness in financial markets are beneficial. This finding is accepted when applied to industrial
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Strahan - The Real Effects of U.S Banking Deregulation...

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