Does an increase in competition increase or decrease bank stability? I use a novel way to capture changes in banking competition by exploring how the exogenous state-specific process of banking deregulation gradually lowered entry barriers into urban banking markets. I find that the increase in market contestability significantly improves bank stability. This result is robust to the inclusion of additional fixed effects and other influences, such as mergers and acquisitions, or geographic expansion. Moreover, I find that greater competition reduces banks’ failure probability, share of non-performing loans and increases profitability. These findings suggest that competition increases stability, as it improves bank profitability and asset quality.

We develop a new identification strategy to evaluate the impact of the geographic expansion of a bank holding company (BHC) across US metropolitan statistical areas (MSAs) on BHC risk. For the average BHC, the instrumental variable results suggest that geographic expansion materially reduces risk. Geographic diversification does not affect loan quality. The results are consistent with arguments that geographic expansion lowers risk by reducing exposure to idiosyncratic local risks and inconsistent with arguments that expansion, on net, increases risk by reducing the ability of BHCs to monitor loans and manage risks.

This paper assesses the impact of the geographic diversification of bank holding company (BHC) assets across the United States on their market valuations. Using two new identification strategies based on the dynamic process of interstate bank deregulation, we find that exogenous increases in geographic diversity reduced BHC valuations. We also find that the geographic diversification of BHC assets increased insider lending and reduced loan quality. Taken together, these findings are consistent with theories predicting that geographic diversity intensifies agency problems.