The Political Economy of Bank Entry Restrictions: Theory and Evidence from the U.S. in the 1920s

Conventional wisdom has it that entry barriers in banking (for example, historical branch banking restrictions in the United States) are motivated by special interest groups, with small, local banks playing a central role in lobbying for protection. In particular, it is thought that unit (single-office) banks in the United States favored branching restrictions because they wanted (and needed) protection from competition from large, multi-office banks. Historically, however, branch banking restrictions also had the support of some classes of borrowers. Borrower support for entry barriers varied across states, and varied over time within states. In our theoretical work, we show that entry barriers affect the terms on which borrowers access credit, and can sometimes be beneficial for some classes of borrowers. While it is true that branch banking tends to increase the overall supply of credit to borrowers, it is also true that in the presence of imperfect capital markets, borrowers may benefit from barriers to entry because such barriers limit the options of the banks in the loan market. We develop two simple models that show how branching restrictions (or more generically, barriers to varying the inter-regional allocation of credit by banks) create strategic advantages for borrowers that hold their wealth in the form of immobile factors of production (e.g., land). In both models these advantages tend to be present only when borrowers' net worth levels are sufficiently high. We report empirical evidence supporting that observation. Our results show that the loan customers that our model predicts should have benefited the most from the strategic advantages of unit banking (landowners in high-wealth states) in fact tended to also prefer unit banking restrictions. By contrast, borrowers that our model predicts would not have benefited as much (landowners in low-wealth states) preferred branch banking. Our results indicate that bank clients, not just unit bankers themselves, may have supported unit banking laws out of informed self interest. We argue that these results also have broader implications for explaining the economic circumstances under which entry barriers to global banking are erected or removed in emerging market economies today.