The political economy of deregulation: evidence from the relaxation of bank branching restrictions in the United States

This paper provides a positive political economy analysis of deregulation, focusing on the recent removal of barriers to bank branching. Intra- and inter- state branching restrictions had been in place in most states for more than a century but have largely disappeared during the last 25 years. Branching restrictions primarily benefit small and inefficient banks against competition from large and efficient banks. Competing financial institutions not subject to the branching laws also benefit from restrictions on their rivals. Consumer and small businesses, however, tend to be harmed by regulations that reduce banking competition. To explain the shift to deregulation, we argue that a recent series of technological and financial innovations caused a change in the long-standing political equilibrium by eroding the value of the restrictions to the beneficiaries. The development and proliferation of the Automated Teller Machine from the 1970s on, for example, have reduced the protection that the potential winners and losers from branching restrictions to explain the pattern and timing of the deregulation across the states. Our results support the political economy hypothesis. First, states in which there are relatively more small banks are more likely to delay the relaxation of the branching restrictions. Second, states in which the small banks are performing poorly relative to the larger banks are more likely to deregulate earlier. Third, in states where banks can sell insurance, the larger is the insurance industry relative to the banking industry, the later is the deregulation. Fourth, states with relatively more small firms are more likely to achieve deregulation earlier. In addition, we analyze voting on the federal deregulation of interstate bank branching in the House and find that the same factors explain the voting behavior of the Representatives. We conclude by drawing lessons about the future path of financial deregulation and the forces driving deregulation more generally.