The introduction of interstate bank branching during the 1990s harmed small businesses and community banks and caused an influx of larger, out-of-state banks to enter deregulated markets, according to an FDIC working paper.
According to the paper, penned by researcher John Lynch of The Ohio State University, the credit supply of small businesses and number of smaller bank branches declined in deregulated states following the passage of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994, which permitted nationwide banking for the first time.
Lynch said small business lending declined on average by 5.4 percent following the law’s implementation, and remained lower for several years. He found that small businesses were often forced to downsize or cut employee hours to accommodate the loss in lending, which sometimes was still not enough to keep them afloat.
“The number of small firms in less regulated markets decreased after several years relative to more regulated markets, and while the number eventually recovered, the total number of workers and hours worked continued to decrease, thereafter, up until the end of the eight-year horizon,” he added.
The working paper contradicts the positive sentiments expressed by supporters of deregulation who cite numerous economic benefits. During an earlier wave of deregulation, from 1978-93, the expansion of banking organizations across state lines occurred by a piecemeal approach. That era, which Lynch said formed the basis of much of the positive current literature on branch deregulation, was also limited to out-of-state bank holding companies acquiring incumbent banking groups. Banking organizations were still not allowed to open branches across state lines nor were they allowed to merge the acquired bank’s assets into their own operations.