Rising Bank Concentration

Abstract: Concentration of insured deposit funding among the top four commercial banks in the U.S. has risen from 15% in 1984 to 44% in 2018, a roughly three-fold increase.

Regulation has often been attributed as a factor in that increase. The Riegle-Neal

Interstate Banking and Branching Efficiency Act of 1994 removed many of the restric-

tions on opening bank branches across state lines. We interpret the Riegle-Neal act

as lowering the cost of expanding a bank’s funding base. In this paper, we build an

industry equilibrium model in which banks endogenously climb a funding base ladder.

Rising concentration occurs along a transition path between two steady states after

branching costs decline. develop a model of banking industry dynamics to study the relation between commercial bank market structure, entry and exit along the business cycle, and the riskiness of commercial bank loans as measured by default frequencies. We analyze a Stackelberg environment where a small number of dominant banks choose their loan supply strategically before a large number of small banks (the competitive fringe) make their loan choices. A nontrivial endogenous bank size distribution arises out of entry and exit in response to aggregate and regional shocks to borrowers’ production technologies. The model is estimated using first moments of aggregate and cross-sectional statistics for a panel of the entire U.S. commercial banking industry. The model is qualitatively consistent with many non-targeted moments; for instance, the model generates countercyclical loan interest rates, bank failure rates, default frequencies, and markups as well as procyclical loan supply and entry rates. The model is used to study the effects of increased bank competition and the benefits/costs of a set of policies: (i)branching restrictions; (ii) lower costs of loanable funds; and (iii) big bank bailouts.