Entry in Banking Markets

We empirically show that adverse selection is a key determinant of banking market structure. Using newly-constructed panel data on all US bank branches over the 1981-2016 period, we study banks' decisions to expand or contract geographically. First, we show that banks are more likely to expand in counties that are similar, in terms of industry shares, to those in which they already have branches. Second, we show that banks are more likely to contract in more similar areas. These results are consistent with the theory that banks value diversification, but that informational barriers to entry prevent them from achieving optimal scale. These findings have implications for the assessment of banking competition and for the rise of fintech.