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How Geographic Diversification in Banks Drives Innovation

In the late 1980s and 1990s, state legislatures passed several acts deregulating banks and allowing them to acquire out-of-state banks. This was followed by a rise in corporate innovation. How did deregulation make this impact?

Connie Mao delves into the impacts of deregulation on banks’ willingness to lend to firms. In this case, the legislation allowed banks to become more geographically diverse, and thereby diversify their risk. This extra risk mitigation gave them the confidence to take more risk in their lending practices.

Mao argues that more liberal lending helps both firms and banks. With increased financial flexibility, firms can more freely test new product ideas. When banks provide loans with more favorable debt covenants, they charge higher interest rates, and thus increase their profits.