Safety in Numbers? Geographic Diversification and Bank Insolvency Risk

96-14

Posted: 10 Sep 1996

See all articles by Joseph P. Hughes

Joseph P. Hughes

Rutgers, The State University of New Jersey - Department of Economics

William W. Lang

Promontory Financial Group

Loretta J. Mester

Federal Reserve Banks - Federal Reserve Bank of Cleveland; University of Pennsylvania - The Wharton School

Choon-Geol Moon

Hanyang University

Date Written: May 1996

Abstract

The Riegle-Neal Interstate Banking and Branching Efficiency Act, passed in September 1994 and effective June 1, 1997, will allow nationally chartered banks to branch across state lines. This act will remove impediments to interstate expansion and permit the consolidation of existing interstate networks. What will be the impact of this legislation on bank performance and bank safety? Removing impediments to geographic expansion should improve the risk-return tradeoff faced by most banks. However, this paper argues that economic theory does not tell us whether an improvement in the risk-return tradeoff will lead to a reduction in the volatility of bank returns or in the probability of insolvency. We investigate the role of geographic diversification on bank performance and safety using bank holding company data. We find that an increase in the number of branches lowers insolvency risk and increases efficiency for inefficient bank holding companies; an increase in the number of states in which a bank holding company operates increases insolvency risk but has an insignificant effect on efficiency. Branch expansion raises the risk of insolvency for efficient bank holding companies, while an increase in the number of states has an insignificant effect on insolvency risk. The views expressed in this paper are those of the authors and do not necessarily reflect those of the Federal Reserve Bank of Philadelphia or of the Federal Reserve System.

JEL Classification: G2, D2

Suggested Citation

Hughes, Joseph P. and Lang, William W. and Mester, Loretta J. and Moon, Choon-Geol, Safety in Numbers? Geographic Diversification and Bank Insolvency Risk (May 1996). 96-14, Available at SSRN: https://ssrn.com/abstract=7718

Joseph P. Hughes

Rutgers, The State University of New Jersey - Department of Economics ( email )

75 Hamilton Street
New Brunswick, NJ 08901
United States

William W. Lang

Promontory Financial Group ( email )

1201 Pennsylvania Avenue, NW
Suite 617
Washington, DC 20004
United States

HOME PAGE: http://www.promontory.com

Loretta J. Mester (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of Cleveland ( email )

East 6th & Superior
Cleveland, OH 44101-1387
United States

University of Pennsylvania - The Wharton School

3641 Locust Walk
Philadelphia, PA 19104-6365
United States

Choon-Geol Moon

Hanyang University ( email )

17 Haegdang-dong
Seongdong-ku
Seoul, 133-791
KOREA

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Abstract Views
1,403
PlumX Metrics