Bank Performance: Market Power or Efficient Structure?

Regulatory change not seen since the Great Depression swept the U.S. banking industry beginning in the early 1980s, culminating with the Interstate Banking and Branching Efficiency Act of 1994. Significant consolidations have occurred in the banking industry. This paper considers the market-power versus the efficient-structure theories of the positive correlation between banking concentration and performance on a state-by-state basis. Temporal causality tests imply that bank concentration leads bank profitability, supporting the market-power, rather than the efficient-structure, theory of that positive correlation. Our finding suggests that bank regulators, by focusing on local banking markets, missed the initial stages of an important structural change at the state level.