Does the Geographic Expansion of Banks Reduce Risk?

Abstract

We develop a new identification strategy to evaluate the impact of the geographic expansion of a bank holding company (BHC) across U.S. metropolitan statistical areas (MSAs) on BHC risk. For the average BHC, the instrumental variable results suggest that geographic expansion materially reduces risk. Geographic diversification does not affect loan quality. The results are consistent with arguments that geographic expansion lowers risk by reducing exposure to idiosyncratic local risks and inconsistent with arguments that expansion, on net, increases risk by reducing the ability of BHCs to monitor loans and manage risks.

Keywords: Bank Regulation, Banking, financial stability, Hedging, risk

JEL Classification: G11, G21, G28