Banking Market Structure and Catastrophic Risk

The project tests the hypothesis that liberalization of banking regulation has different effects on banks depending on whether they are faced with high or low undiversifiable risks in their home markets. The particular event that is considered is the “Interstate Banking and Branching Efficiency Act (IBBEA)” of 1994, which allowed unrestricted Interstate banking and interstate branching in the U.S. In order to differentiate between banks that are faced with high or low undiversifiable risks, the team looks at catastrophic risk from hurricanes, earthquakes and other natural disasters over the last 50 years. For example, banks doing business in the U.S. Gulf coast area face high undiversifiable risk because a hurricane affects many of their borrowers at the same time. In contrast, banks in the Chicago area do not face this kind of undiversifiable risks.

Hence, using a difference-in-difference estimation technique, the identification strategy allows to explore whether the liberalization of banking regulation through the IBBEA in 1994 had different consequences for banks facing high (catastrophic) undiversifiable risks and banks facing low (catastrophic) undiversifiable risks.

Results show that catastrophic risk matters for the effects of the liberalization through the IBBEA of 1994 on banks. In particular, banks that face high (catastrophic) un-diversifiable risks in their home markets diversify more actively after the act compared to the banks that face low (catastrophic) undiversifiable risks.