Banking and Stability

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Finance and Economics Discussion Series

Divisions of Research & Statistics and Monetary Affairs

Federal Reserve Board, Washington, D.C.

Branch Banking, Bank Competition, and Financial Stability

Mark Carlson and Kris James Mitchener

2005-20

NOTE: Staff working papers in the Finance and Economics Discussion Series (FEDS)

are preliminary materials circulated to stimulate discussion and critical comment. The

analysis and conclusions set forth are those of the authors and do not indicate

concurrence by other members of the research staff or the Board of Governors.

References in publications to the Finance and Economics Discussion Series (other than

acknowledgement) should be cleared with the author(s) to protect the tentative character

of these papers.

Branch Banking, Bank Competition, and

Financial Stability

Mark Carlson

and

Kris James Mitchener*

March 2005

JEL Codes: G21, N22, E44

It is often argued that branching stabilizes banking systems by facilitating diversification of bank

portfolios; however, previous empirical research on the Great Depression offers mixed support

for this view. Analyses using state-level data find that states allowing branch banking had lower

failure rates, while those examining individual banks find that branch banks were more likely to

fail. We argue that an alternative hypothesis can reconcile these seemingly disparate findings.

Using data on national banks from the 1920s and 1930s, we show that branch banking increases

competition and forces weak banks to exit the banking system. This consolidation strengthens the

system as a whole without necessarily strengthening the branch banks themselves. Our empirical

results suggest that the effects that branching had on competition were quantitatively more

important than geographical diversification for bank stability in the 1920s and 1930s.

*

Carlson: Federal Reserve Board; 20th and Constitution Ave, NW; Washington DC 20551;

Mark.A.Carlson@frb.gov....