The Effects of Banking Competition on Growth and Financial Stability: Evidence from the National Banking Era
69 Pages Posted: 16 Jul 2018 Last revised: 23 Jan 2019
Date Written: January 21, 2019
How do restrictions on banking competition affect credit provision and economic output? And, how do they affect financial stability? To identify the causal effect of banking competition, we exploit a peculiarity of bank capital regulation in the National Banking Era: opening banks in towns with more than 6,000 inhabitants required twice the equity as in towns below this threshold, thus leading to a locally exogenous variation of entry barriers. We construct a novel comprehensive data set comprising the annual balance sheets of all national banks, and link it with the results of the decennial census. We show that banks operating in markets with lower entry barriers extend more credit and choose a higher leverage. The resulting local credit boom, in turn, is associated with an expansion in the local manufacturing industry. However, banks in markets with lower entry barriers are also more likely to default or go out of business during a major financial crisis. Altogether, we provide causal evidence that credit growth can cause both, economic growth and financial instability.
Keywords: Banking, Banking Competition, Risk Taking, Credit Provision, Real Effects, Financial Crisis, Panic of 1893, Economic history, National Banking Era
JEL Classification: G00, G01, G20, G28, N2, N21
Suggested Citation: Suggested Citation