Study: Banking Deregulation Leads to Increased Business Productivity

Published May 19, 2015

In the 19th century, national and state regulations restricted intra- and interstate banking, but during the 20th century, many states dismantled these regulations and allowed some forms of interstate banking, such as permitting out-of-state banks to buy banks in the state.

The enactment of the Interstate Banking and Branching Efficiency Act of 1994 (IBBEA) allowed banks to have branches in more than one state.

In our forthcoming paper, “Does Financing Spur Small Business Productivity? Evidence from a Natural Experiment,” Brandeis University International Business School associate professor of Finance Debarshi K. Nandy, Duke  University Fuqua School of Business professor of finance Manju Puri, and I analyze how the interstate expansion of banking and bank branching, starting in 1994, affected small and large businesses’ productivity.

‘Free Flow of Capital’

Free-market principles suggest the free flow of capital leads to a greater accessibility of capital, allowing firms to invest efficiently.

Firms can use more or cheaper capital to invest in productive projects they would otherwise not have access to, enhancing their productivity.

This principle has important policy implications, particularly when local, state, and national government budgets are stressed by economic conditions. For policymakers, the pertinent question is how to spur growth of local entrepreneurial firms?

Using data from the U.S. Census Bureau on a large sample of private manufacturing firms, we find productivity of firms located in a state increased when the state allowed out-of-state banks to enter its borders.

Less Regulations, More Productivity

Firms located in states with fewer regulations and that impose fewer restrictions on the entry of out-of-state banks experienced a greater increase in their productivity following banking deregulation in that state.

Smaller and more financially constrained businesses were the primary force behind the empirical results. Specifically, smaller firms’ productivity increased more than larger firms’ after banking deregulation. This observation was consistent regardless of how firm size was measured.

Broadly speaking, allowing capital to flow more freely between geographic locations helps smaller and financially constrained firms invest in productive projects, enhancing their performance.

Firms are more effective if artificial barriers to the flow of capital are removed, at least within the geographic context of the United States the study sampled.

Karthik Krishnan ([email protected]) is assistant professor of finance at Northeastern University and a policy advisor for The Heartland Institute.

Internet Info:

Karthik Krishnan, et al., “Does Financing Spur Small Business Productivity? Evidence from a Natural Experiment,” National Bureau of Economic Research: