03 Jan 2007Working Paper Summaries

Banking Deregulation, Financing Constraints and Entrepreneurship

by William Kerr and Ramana Nanda

What effect does an increase in banking competition have on the entry of start-ups? In particular, does an increase in banking competition have a differential effect on the entry of start-ups relative to the opening of new establishments by existing firms? The U.S. branch banking deregulations provide a useful laboratory for studying how banking competition affects small businesses. Prior to 1970, all but twelve states had stringent restrictions on the ability of banks to open new branches or to acquire the branches of other banks within the state; beginning in the 1970s and until 1994, all but two states removed these restrictions. In this research, Kerr and Nanda studied the entry of newly incorporated businesses between 1976 and 1999 using detailed data collected by the U.S. Census Bureau. Their findings matter for understanding how reforms that affect the financing environment may improve the real economy through the reallocation of resources in the non-financial sectors. Key concepts include:

Interstate branch banking deregulations had a positive effect on both the entry rates and entry sizes of start-ups relative to the facility expansions of existing firms.
These beneficial effects were evident in multiple sectors of the economy and stronger in more financially dependent industries.
While greater banking competition may hurt entrepreneurs through a decline in relationship banking or loan subsidization, the positive net effects point to substantial increases in credit provision to start-ups.
The impact of financial market reforms on product market entry is an important micro-foundation for understanding and fostering economic growth.

Author Abstract

We study how U.S. branch banking deregulations affected the entry of new firms in the non-financial sector using establishment-level data from the U.S. Census Bureau's Longitudinal Business Database. The comprehensive micro-data allow us to study how both the entry rate and the distribution of entry sizes for new startups responded to changes in banking competition. Moreover, we distinguish the relative effect of the policy reforms on the entry of startups compared to the opening of new establishments by existing firms. We find interstate banking deregulations had a strong positive effect on the birth of new firms relative to the facility expansions of existing firms. We find limited evidence that the intrastate banking deregulations influenced entry. Our results have implications for existing theories of financial constraints for entrepreneurs, as well as research looking at the effect of banking competition on the efficient allocation of capital.