Money and Banking: Dollarization: Is Distance Dead in Banking? - Expand Your Insight

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"Concentration, Technology, and Market Power in Banking: Is Distance Dead?" Financial Industry Studies December 1998 (Text or PDF)

Money and Banking
Is Distance Dead in Banking?

Financial Industry Studies Economist Robert R. Moore explores the diminishing role of distance in banking.

What is "the death of distance"?
Technological advancement is making distance a less formidable barrier than it once was. In her 1997 book The Death of Distance, Frances Cairncross argues that technological advancements are on their way to making distance virtually irrelevant in economic transactions. The competitive ramifications of this would be profound: a seller down the block would no longer have a distance-based advantage over a seller on the other side of the country, or even the world.

The benefits of vigorous competition under a free market system have long been recognized. Advancing technology is promoting competition in new ways by diminishing the barrier of distance in banking.

What is a banking market?
The traditional focus on relatively small geographic areas is linked to the historical importance of distance as a barrier in banking; to the extent that it was historically difficult to transact with distant banks, they were excluded from the market definition. Consistent with banking markets being confined to local areas, two recent surveys find that only a small fraction of consumers and small businesses use commercial banks outside their local area (Kwast, Starr-McCluer, and Wolken 1997). Cyrnak (1998) finds, however, that lenders outside the local market play an important role in making loans to small businesses, especially in rural areas. The differences between these studies' findings highlight the challenge of defining banking markets for regulatory purposes.

To promote competition, the traditional approach to antitrust enforcement in banking is to view the market for banking services as local and geographically limited. However, if distance is becoming less relevant in banking, then local market concentration should be a less important determinant of profitability. The evidence in Financial Industries Studies (December 1998) is consistent with the presence of nearby competitors influencing the competitiveness of rural banking markets in 1986 and 1987. In 1996 and 1997, however, the data are no longer consistent with that view: the presence of nearby competitors no longer helps to explain the profitability of the banking market, suggesting that markets for banking services are now geographically broader than before.

The change in the relationship between local market concentration and profitability over the past ten years accords with recent changes in technology. Falling communication costs are making distant competitors increasingly important, since lower communication costs make obtaining information about and transacting with distant banks more economical.

The adoption of banking by personal computer has the potential to downplay distance even further. Already, over 300 U.S. banks offer services over the Internet. For interaction over the Internet, the physical distance between the customer and the bank is irrelevant.

While the results presented here are not sufficient to pronounce distance dead in banking, they are consistent with a weakening of its role. Banks continue to maintain and grow extensive branch networks, suggesting that a substantial number of customers still value geographic proximity. However, the conduct and performance of banks appear to depend less now on the physical presence of competitors in local markets, suggesting that linkages between local areas and the broader banking market are stronger now than in the past.

Banking and antitrust policy
Competition has long been viewed as essential for market forces to work in the best interest of an economy. In recognition of the importance of maintaining competition, the United States enacted various laws near the turn of the twentieth century that were intended to ensure adequate competition. One such law was the Clayton Act of 1914, which prohibited mergers if they would substantially reduce competition. Some uncertainty existed about the applicability to banking of the turn-of-the-century antitrust laws and their subsequent amendments, but the Philadelphia National Bank case of 1963 made it clear that banks were subject to those laws.

Robert Moore is a senior economist and policy advisor at the Federal Reserve Bank of Dallas.

REFERENCES:

1.
Cairncross, Frances (1997), The Death of Distance: How the Communications Revolution Will Change Our Lives (Boston: Harvard Business School Press).

2.
Cyrnak, Anthony W. (1998) "Bank Merger Policy and the New CRA Data," Federal Reserve Bulletin 84, September, pp. 703-15.

3.
Kwast, Myron L., Martha Starr-McCluer, and John D. Wolken (1997) "Market Definition and the Analysis of Antitrust in Banking," Antitrust Bulletin 42 (Winter): pp. 973-95.

SUGGESTED CITATION:
Moore, Robert (1999), "Is Distance Dead in Banking?," Federal Reserve Bank of Dallas Expand Your Insight, November 1, http://www.dallasfed.org/eyi/money/9911.html