February 1997

The Performance of De Novo Commercial Banks (WP 97-3)

This publication is a part of:

Collection: Economics Working Paper

Abstract

Federal and state bank regulators have granted over 3,000 new bank charters since 1980. These new banks can provide the interbank rivalry necessary to keep local markets competitive in a consolidating industry. However, unless they are operated in an efficient fashion, newly chartered banks may not survive their first few rocky years of existence, and even those that survive will not make strong rivals for incumbent banks. We estimate profit efficiency for the entire population of small, urban commercial banks in 1988, 1990, 1992, and 1994, and use those estimates to track the improvement in de novo bank performance over time. Our results suggest that efficiency improves rapidly at the typical de novo bank during its first three years of operation, and that the average de novo bank attains established bank efficiency levels after nine years. We find that excess branch capacity, reliance on large deposits, and affiliation with a multibank holding company are all strongly related to low profitability at newly chartered banks. Our results also suggest that a laissez-faire chartering policy can enhance competition in local markets without creating long-term problems for industry safety and soundness.

Authors

Robert DeYoung and Iftekhar Hasan