Bank Deregulation


Table of contents


Introduction ……………………………………………………………………………………4

Literature review………………………………………………………………………………..5

Beneficiaries of bank deregulation…………………………………………………………….6

Federal Reserve and Recession………………………………………………………………..9

Conclusion ……………………………………………………………………………………10


Table of figures

Figure 1: Income Stabilization After and Before Deregulation………………………… 7









This paper clearly summarizes the effects of banking deregulation of limitations on bank expansion and entry on the overall economic growth in the United States. Several states relaxed the restrictions regarding intra-state bank branching starting 1960s by permitting bank holding corporations to change subsidiaries to become branches and also by allowing nationwide de novo branching. Consequently, it increased the competition within the banking sector forcing the financial intermediaries to turn out to be more efficient. The proof suggests that economic growth within the states accelerated following the deregulation of restrictions in the country. A superior growth was actually noticed within the entrepreneurial sector.

Additionally, macroeconomic stability picked up as a result of interstate deregulation that enabled the banking system to integrate transversely within state borders. Studies extend to reveal that one of the strategies that helped the banking sector to be efficient was basically the focus on bank lending where different institutions have varying levels of dependence towards the external financing. Most of the industries and financial institutions that are likely to be dependent on the external financing will experience a rapid growth during the post-deregulation although other studies reveal that some of the banking institutions in the United States that borrow less funds grew rapidly after the deregulation.





1. Introduction

Banking deregulation refers to the elimination of regulations that revolve around the finance industry. It will be documented that in 1980 the Act related to bank deregulation was passed that did away with the interest rate regulation in the savings accounts and other things. This made most of the finance institutions to surpass the other companies in the market. The larger banks merged with one another while others acquired the smaller banks The American history regarding banking began from the establishment of Pennsylvania Bank in Philadelphia in 1780 which was geared at providing funding to the Continental Army that fought the Revolutionary War and the Philadelphia merchants (Mullineux, 2012).

During 1970s, the commercial banks in the United States faced stiff restrictions towards the interest rates which applied both on the lending as well as the deposit sides of the financial institutions. They were actually constrained for the most fragments to typical financial intermediation where they were restricted from lending and deposit taking for instance underwriting insurance products and corporate securities. It will also be documented that the financial institutions were also limited in terms of geographical scope for most of their operations. This ensured that a state could not allow those banks which were actually headquartered in other countries or states to acquire their banks or open branches which made many of the states to restrict or prohibit intrastate branching. Currently, most of these restrictions have truly been lifted. The ceilings on interest rate particularly on the deposits were fully phased out during 1980s and the laws regarding the state usury have weakened since the banks can lend anywhere and the limitations on the ability of the banks to engage in supplementary financial activities have truly been eliminated. This has made the banking system in the United States to be more consolidated both horizontally and vertically as well as being more competitive.

2.0 Literature review

There is a large quantity of literature on the effect of financial development towards the economic growth of any state although several economists refute this ideology. This argument developed from the differing views of Robison (1979), who claimed that causality originated from growth of the economy towards financial development since the states with excellent growth prospects are likely to build up their financial segment while Schumpeter and Röpke (2006), claimed that causality originated from financial development towards economic growth for the reason that a state that was obstructed by inadequate capital may possibly not grow.  A massive body of work based on this argument has been carried out since then regarding money and banking particularly on the empirics, theory as well as the banking deregulation of within different states (Holmstrom and Tirole, 1997). Holmstrom and Tirole further argued that bankers can decrease volatility through a clear monitoring within the firms and can also augment the level of volatility by dodging their responsibilities in monitoring.

Studies have been carried out to show that control of several factors such as economic shocks and macroeconomic conditions, institutional quality as well as regulatory policies then systematic or regular banking crises are not expected in those states with excessive concentrated banking structures that have smaller number banks (Beck and Demirguc-Kunt,  2003). Concentration is obtained by taking the assets ratio of the largest three banks to the total assets of the banks in the state. A systematic or regular crisis refers to the period when the banking system is incapable to carry out any intermediary role towards the economy and urgent assistance is provided to the particular banking system.

It will be documented that fewer banks results to an extra market power as well as higher profits which help these banks to be in good health during adverse shocks. Sky-scraping profits raise the banks’ charter value hence decreasing the risk-taking inducements for managers. It also becomes easier to regulate small number of banks in the industry. This is because the huge number of banks in the United States had more unstable history in there financial status as compared to Canada and U.K which have fewer banks (Allen and Gale, 2000).The bank integration witnessed in U.S as a result of the deregulation lessened the   financial constraints within most of the publicly-traded corporations that greatly depend on the exterior financing by increasing the shares of those banks that are locally headquartered and diversified (Correa, 2008). Those banks that are technologically advanced acquire the local community banks which in turn help them to obtain larger credits. Deregulation permits most of the banks to obtain supplementary business loans with no increment in their overall risk making them to pass on the economies and become external finance-dependent corporations.

3.0 Beneficiaries of bank deregulation

Bank deregulation helps in increasing the level of competition as well as encouraging cost savings. It actually reduces the entry barriers for the potential entrants in the market. Studies reveal that when new firms enter in the industry, the level of competition increases making the customers to have supplementary choices for services and products in the market (Calomiris, 2000).Through bank deregulation, a financial institution is able to reduce its prices so as to achieve an extra competitive position within the market. In addition, deregulation actually provides cost savings to their customers. Through the elimination or reduction of tariffs, prices tend reduce increasing customers demand as well as the company’s profits while passing a cost reduction to the customers.

Deregulation truly began in 1970s which constituted of the intrastate and interstate deregulation that enabled nationwide branching through acquisitions and mergers plus the free creation of multistate bank holding corporations. The banking deregulation has helped most of the small banks within the United State to survive in the competitive environment. Intrastate branching limitations, in collaboration with restrictions that revolve around the creation of multistate bank investment corporations strictly limited the ability of the banks to diversify most of their portfolios geographically.  These made most of the banks in regulated states to be tied more closely to the local economy leading to limited capacity to either assist local businesses put up with their risks or endure local shocks within the economy (Demyanyk, Ostergaard & Sorensen 1b, 2007). The home office laws of protection prohibited most of the outside banks from establishing new branches in the rural areas or small towns where another bank already existed. These regulations helped most of the small community banks to be shielded from the competitive pressures within the growing banking system by ensuring that the more-efficient banks do not enter in the market. This prevents the small banks from being kicked out of the market.

Figure 1

Income Stabilization After and Before Deregulation


SOURCE: (Demyanyk, Ostergaard and Sorensen 1a, 2007).

It will be realized that small banks actually depend on the bank finance by a larger proportion than the large businesses that are capable of issuing stocks and bonds. Due to their continued dependence on banks, most of the owners of the small businesses had an inferior ability in stabilizing their revenues during the periods of high regulations of the banking industry.  From the figure above it will be realized that those states which had comparatively more small banks had actually smaller degree of stabilizing their income on average before the deregulation as compared those that had less small businesses. The banking industry turned out to be more integrated, geographically diversified and competitive after the deregulation which by a large extend helped in stabilizing the income of the small businesses.

This was further fueled by the fact that the bank lending level towards the businesses increased as those banks that were more efficient could screen most of the business projects. The banks also improved the relationships that existed between the business borrowers which necessitated the banks to offer credits even during periods of economic recessions. On the other hand, interstate deregulations affect the bank corporations’ consolidation across the state margins and in turn will have a less impact towards the local markets. The aptitude to run multistate bank investment corporations is probable to have an affirmative impact on risk-sharing as well as banking efficiency although such improvements will actually benefit both the small and large business owners.




4.0 Federal Reserve and recession

Although bank deregulation leads to price reduction of the bank’s products and services which is very essential for its customers, it has a negative impact to most of the financial institutions particularly the small banks. Bank deregulation may reduce the interest rates for the savings account which makes threatens the survival of the smaller banks in the competitive market. Most of these smaller financial institutions have been acquired by the larger banks hence been swept out of the market. Additionally, bank deregulation has resulted to poor service quality offered by some of the financial institutions (Matasar & Heiney, 2002). Deregulation which was highly upheld by the Republicans ever since 1980s is actually behind most of the recessions that occurred in the country particularly the economic meltdown of 2008. The contractionary monetary policy that was adopted by Federal Reserve System in their view to control inflation necessitated the continued recessions within the states.

Banking deregulation which phased out several restrictions on the financial practices of the banks truly widened the lending powers of the banks as well as raising the limit of the deposit insurance which in turn increased the moral hazard problem. The Federal Reserve has in fact taken measures in order to repair the economy in during recessions. Monetary policy strategies are adopted by the American central bank to ensure that economy pulls out of the economic meltdown (Seidman, 2004).  It considers lowering the interest rates so as encourage more investments that help in increasing its gross domestic product. Another monetary policy option that is geared at fighting recession is through lowering the reserve requirements. In addition, the Federal Reserve buys government securities such as treasury notes and bills that by a large extend helps repairing the economy (Brezina, 2012).


5.0 Conclusion

The restrictions associated with the banking deregulation especially on the interstate banking and branching have led to emergence of constraints that prevent large efficient banks from surpassing their efficient rival competitors. The changes within the banks have also necessitated better services towards their customers as well as passing lower prices to them. On the other hand, bank deregulation has been associated with recession though the Federal Reserve uses monetary policy strategies to bring back the economy in operation.














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