by Ross Levine
It is crucial to understand the impact of the geographic diversification of a bank’s assets on its funding costs because (1) the costs to banks of raising capital, issuing other securities, and attracting deposits affect the allocation and pricing of bank credit, which are central to economic growth and the distribution of income and (2) banks expand geographically for many reasons, raising questions about the impact of such expansions on funding costs and bank lending. Existing research, however, offers differing perspectives on whether the geographic diversification of bank branches and subsidiaries increases, decreases, or has no effect on the costs to banks of raising deposits and issuing securities. This research will provide the first empirical evaluation of the impact of geographic expansion on the costs of a bank’s interest-bearing liabilities, which account for about 90 percent of bank liabilities. A crucial methodological contribution is the development of an empirical strategy to identify the impact of an exogenous source of variation in the geographic expansion of a bank on its funding costs.