Firm Volatility and Banks: Evidence from U.S. Banking Deregulation

Abstract

This paper exploits the staggered timing of state-level banking deregulation in the U.S. during the 1980s to study the causal effect of banking integration on the volatility of non-financial corporations. We find that firm-level employment, production, sales, and cash flows are less volatile after interstate banking deregulation. The decrease in volatility is stronger for firms that have limited access to external finance, suggesting that bank-dependent firms exploit wider access to finance after deregulation to smooth out idiosyncratic shocks. In fact, short-term credit becomes less procyclical after out-of-state bank entry is permitted. Finally, lower volatility in real-side variables after deregulation translates into lower idiosyncratic risk in stock returns. If deregulation enhances efficiency in intermediation and promotes the development of the banking system, our results suggest that banking development may lower firm volatility in non-financial sectors.

Keywords: Volatility, bank regulation, external finance

JEL Classification: G21, G32