Deregulation of Bank Entry and Bank Failures

Does deregulation of bank entry enhance bank stability or exacerbate bank fragility? Since the theoretically predicted effect of deregulation of bank entry on bank failures is ambiguous, this question has to be answered empirically. In this paper, we analyze the impact of deregulation of entry restrictions in the U.S. states on bank stability. We find that deregulation of bank entry enhances bank stability by lowering instances of bank failures. Consistent with the effects being strongest in environments where the structure of banking markets change the most, the effects are mainly due to intra-state deregulation and in states that had unit banking laws. We do not find any placebo effects as evidenced by deregulation having no effect on failure of thrifts. Furthermore, pre-existing bank failures in a state did not determine its timing of deregulation, which assures against any reverse causal effects. The reduction in bank failures seemed to result from: (i) benefits from greater geographic diversification; and (ii) banks becoming more efficient post deregulation