Competitive Dynamics of Deregulation: Evidence from U.S. Banking

This paper examines the impact of increased competition from deregulation on the dynamics of the U.S. banking industry. We find the link between a bank’s relative performance and its subsequent market share growth strengthens significantly after deregulation as competitive reallocation effects transfer assets to better performers. The increase in the link is strongest in states that were initially more regulated and therefore likely to be less competitive, e.g., states with unit banking restrictions and high market concentrations. Exit dynamics also change in ways consistent with the disciplinary role of competition. After states deregulate, both the exit rates and the average profitability of exiting banks increase as more banks are exposed to the corporate takeover market. The net effect of these forces is a substantial reallocation of market share toward better banks. We conclude that earlier regulation of U.S. banks blunted this market mechanism and seriously hindered the competitive process. Stiroh is a Research Officer at the Federal Reserve Bank of New York. Strahan is an Associate Professor of