Branch banking, holding companies and universal banking in the United States

This dissertation delineates the role of regulation and economic factors in determining the US banking structure. Specifically, it focuses on the development of universal banking and on the extent of geographical expansion undertaken by banks. The first chapter traces the evolution of intra-state branch banking. It points out that historically there existed certain states where banks were legally permitted to branch but chose not to do so. The theoretical model developed shows that while branching allows a bank to diversify it's portfolio, it also poses the problem of weeding out more risky borrowers without a priori information. Costly verification can dilute the benefits of expansion especially if the opportunity to diversify is limited. Empirical evidence presented shows that predominantly agricultural states which offered limited diversification possibilities were also the states where branch banking was underdeveloped. The second chapter explains the rationale behind limited inter-state expansion via holding companies prior to 1933. The possibility to conduct both commercial and investment banking activities provided banks with an incentive to set up local offices in order to establish long-term relationships with firms. However, a theoretical model shows that there existed an inefficiency in the holding company structure vis-a-vis branch banking: a holding company had the ex-post possibility to refuse to indemnify the liabilities of a member bank. This allowed it the option to transfer worthless assets from all banks under its control to one bank which was then allowed to go under. Empirical evidence presented supports the results of the model. The final chapter empirically tests the validity of the importance of a local bank office for performing 'efficient' universal banking activities. It contrasts the performance of banks which underwrote local securities with banks which underwrote securities for firms outside the area of their commercial bank operations. A comparison of the initial net yield to maturity of ex-ante similar securities issued by the two sets of commercial banks shows a statistically significant lower yield for those banks which underwrote local firms. This strengthens the case for information production by commercial banks through the loan-making process.