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ESSAYS ON ISSUES THE FEDERAL RESERVE BANK MAY 2007 OF CHICAGO NUMBER 238 Chicago Fed Letter The branch banking boom in Illinois: A byproduct of restrictive branching laws by Tara Rice, financial economist, and Erin Davis, equity analyst, Morningstar Inc. What’s behind the boom in bank branches across Illinois, particularly in Chicago? The authors explore the history of branch banking within the state and across the nation to help explain this recent trend and discuss its future implications. Bank branches, like coffee shops, have be- The state of Illinois was one of the most come a ubiquitous part of the American restrictive bank branching states in the landscape. In Chicago’s commercial country. It was what is known as a “unit banking district, twelve banking offices banking” state in which each bank was now dot LaSalle Street between the allowed to operate only one office.3 The Chicago River and the Chicago Fed, state constitution of 1870 prohibited more than double the five coffee shops branch banking, and that prohibition along this half-mile stretch.1 remained in place until the mid-1960s. The first revision, adopted in 1967, al- As of June 30, 2006, Illinois boasted 4,349 lowed a bank to operate one additional As of June 30, 2006, Illinois banking offices, two-thirds more than drive-up facility within 1,500 feet of the in 1994.2 This aggregate state growth boasted 4,349 bank branches, unit bank. By 1985 banks were allowed is unusual, since the number of bank- 66% more than in 1994. to have up to five offices, two of which ing offices nationwide grew only 23% could be in other counties if they were lo- This statewide growth is between 1994 and 2006. Politicians cated no more than ten miles from the extraordinary; the number of in Illinois have begun to take notice. head office. Finally, in 1993, the limita- The City of Chicago amended Chapter branches nationwide grew just tions on interstate branching were com- 17-3-0504-I of its zoning code in 2004 23% between 1994 and 2006. pletely removed; for the first time Illinois to require banks to apply for special use banks were allowed to branch freely within permits to build new banking offices the state. These laws applied both to na- in certain areas, and several Chicago tional banks chartered by the federal gov- suburbs have enacted similar restric- ernment and to state banks chartered by tions. In this Chicago Fed Letter, we ex- the individual state regulatory agencies.4 plore the reasons behind the recent bank branching boom and discuss Until 1994, federal law prohibited bank its implications. branching across state lines. The Riegle– Neal Interstate Banking and Branching The history of branch banking in Illinois Efficiency Act (IBBEA) removed these In large part, the current trend in bank- restrictions when enacted in 1994. IBBEA ing office growth is a product of Illinois’ allowed states to opt in to interstate banking history. Restrictive bank branch- branching and, if they chose to do so, ing laws in Illinois suppressed expansion determine how restrictive statewide pro- for decades. With the relaxation of these visions on interstate branching could restrictions, the number of banking of- be. Illinois opted in to IBBEA in 1997 fices has increased sharply in the last and, as of 2004, allows nearly unrestrict- dozen years or so. ed interstate branching. 1. Banks and banking offices in Illinois, 1935–2006 concentration of its These two observations—that Illinois’ banking markets. banking markets are relatively unconcen- 4,500 In 2006, Illinois was trated and that Illinois has experienced 4,000 less concentrated higher branch growth—are related. than 42 states, while Figure 2 shows this pattern: The trend 3,500 Chicago was the line illustrates a negative relationship 3,000 sixth least concen- between branch growth and market 2,500 trated metropolitan concentration. This figure plots the banking area out of 369 met- percentage growth in banking offices 2,000 offices ropolitan areas in with our measure of market concentra- 1,500 the U.S. tion for the largest 15 cities. Chicago is 1,000 located in the top left-hand corner of Figure 1 shows the banks the figure, above the line; of these 15 500 change in the total cities, it has experienced the highest 0 number of banks ver- 1935 ’40 ’45 ’50 ’55 ’60 ’65 ’70 ’75 ’80 ’85 ’90 ’95 2000 ’05 branch growth and remains the most sus the total number OTES competitive market. Interestingly, five N : Vertical lines represent years of branch banking deregulation. Banking of banking offices offices include both main offices (banks) plus “other” offices (branches) of state of the seven cities plotted above the trend and national banks. from 1935 through SOURCES: Authors’ calculations based on data from the Federal Deposit Insurance line are located in states that were once Corporation and Federal Reserve System. 2006; the vertical unit banking states. lines represent major regulatory changes The political economy of bank The explosion of bank branches in Illinois. The total number of banks branching In addition to suppressing banking was fairly constant until 1967, and near- There are a number of reasons why office growth, Illinois’ once restrictive ly all of these were unit banks. Banks Illinois and many other states enacted branching environment also protected were able to expand their branch net- restrictive branching regulations. One small banks, allowing a relatively large works, to a limited extent, by acquiring objective was to limit the power of banks number of them to operate in the state. existing banks. As banks merged, the by constraining their size. Opponents In 1994, Illinois had 994 banks (0.84 number of banks operating in Illinois of branch banking thought that if banks banks per 10,000 residents) with an grew more slowly and, after 1980, began became too large they would exert ex- average of $296 million in assets (in to fall. In 1988, legal changes steepened cessive political and economic influence.7 2006 dollars). Nationwide (excluding this decline; Illinois began to allow bank Residents were concerned that if big Illinois), each state had on average 207 holding companies with more than one banks were allowed to branch into small banks (0.60 banks per 10,000 residents) bank to merge their banks without giving towns, they would siphon deposits out with $671 million in assets (in 2006 dol- up any of the branches. of these towns and use them to make lars). Today, though there are fewer Figure 1 also highlights the banking loans to larger clients in financial cen- banks nationwide, Illinois is still home office growth. When intrastate branch- ters.8 As a result, small businesses and to more small banks than other states, ing restrictions were relaxed, branch local communities would be without the on average. As of June 2006, Illinois expansion boomed. Many institutions capital they needed to thrive. Branching had 650 banks (0.54 banks per 10,000 began to compete for market share, as restrictions were also intended to make residents) with $545 million in assets, larger out-of-state banks began acquir- banking safer by shielding banks from while other states had on average 145 ing and building banking office net- excessive competition9 and to protect banks (0.43 banks per 10,000 residents) works in Illinois and existing Illinois and enhance state banking regulation with $1,858 million in assets. banks opened additional banking of- fees, which made up a large percentage 10 Because this environment allowed many fices.6 The combination of large out- of many states’ revenues. small banks to exist, Illinois’ banking of-state banks and small Illinois banks The banks that were the beneficiaries markets were among the least concen- fueled the banking office growth, which of these regulations were naturally strong trated in the country (measured at both appears more dramatic when com- supporters of branching restrictions. the city level and state level), and this pared with national averages. In 1967, Bankers in small towns, in particular, trend continues today. Using a com- each state in the U.S. had on average lobbied effectively against branch bank- mon measure of market concentra- 1.86 banking offices per 10,000 resi- ing, motivated in part by their desire to tion, Illinois was less concentrated than dents, while Illinois had only 0.99. Only insulate themselves from competition 5 47 states in 1994. Back then, Chicago one state (Florida) had fewer banking by larger out-of-state banks.11 was the third least concentrated metro- offices per capita. By 1994, Illinois had politan area out of 369 metropolitan 2.20 banking offices per 10,000 residents. Experience has shown that branch bank- areas in the U.S. Interestingly, the re- This rose to 3.39 banking offices per ing did not merit many of these early laxation of branching restrictions in 10,000 residents by 2006, surpassing concerns. When states introduced state- Illinois did not significantly change the the national average of 3.21. wide branching, banks’ loan losses and 2. Market concentration and branch growth in largest 15 cities, 1995–2006 announcements by Chicago banks give no clear indication. Several banks plan percent of branch growth per 10,000 residents to build additional branches in Chicago 100 in hopes of generating new accounts; estimates suggest that more than 90% 80 • Chicago, IL of new transaction accounts in the U.S. 20 60 are opened at physical branches. Dallas, TX Conversely, the market may be posed 40 San Antonio, TX • • Houston, TX for a slowdown in branch growth, as • 20 • Detroit, MI several financial institutions announced Philadelphia, PA Jacksonville, FL San Jose, CA • plans to close underperforming branches 0 • • • • • • • San Francisco, CA 21 New York, NY Indianapolis, IN in the Chicago area.

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