Academic journal article
By Economopoulous, Andrew; O'Neill, Heather
Journal of Money, Credit & Banking , Vol. 27, No. 4
It has long been believed that the establishment of the free banking laws was a move by state legislatures to provide greater access to the bank market and to increase bank competition. Kenneth Ng (1988) challenged the traditional views that these laws provided greater access to the market and that the legislative approval system of bank chartering enhanced competition. Ng points out that in states that enacted free banking laws, such as Massachusetts, Vermont, Georgia, Alabama, and Florida, few free banks actually entered after the introduction of the free banking laws. This inactivity suggests that some of the provisions of the new laws may have precluded easier entry. In addition to those free banking states that showed little free bank entry, Ng finds that relative growth rates of bank assets in free banking states were not significantly different from those of the region or the nation. He concludes that "the absence of unusual growth in free banking states suggests that free banking laws exchanged one set of barriers contained in the legislative charter system for different, but equally effective barriers."(1)
The use of relative growth rates, however, does not necessarily show a change in barriers to entry for two crucial reasons. First, the use of relative growth rates of bank assets to estimate entry fails to distinguish between barriers to new entry and barriers to scale economies. A banking system's assets could increase without new entry if all banks in the system increased financial leverage or if the existing banks increased the level of retained earnings. In the short run, chartering states could have competed with the free banking states while still having significant barriers to new entry if their growth rates were attributed to scale economies. Consequently relative growth rates in bank assets could be similar in free banking and chartering states.
Second, as Ng pointed out, the enactment of the free banking laws may have had interstate effects.(2) The free banking laws may have induced chartering states to liberalize their chartering policies. Thus, the free banking laws may have induced the non-free banking states' legislatures to institute a different chartering policy designed to increase the number of charters.(3)
This paper reexamines the impact of the free banking laws on barriers to entry in both charter and free banking states before and after enactment. We include in the analysis the effects of economies of scale on entry and the change in chartering policies of chartering states. In the next section, a brief review of entry policy and activity is given. In section 2, a competitive model of bank entry is presented. In section 3, a description of the data and the estimation procedures for cross-sectional time series data are given. In sections 4 and 5 we test capital formation and bank entry, respectively, to examine differences in entry between alternative state banking systems.
1. ENTRY POLICY AND ACTIVITY DURING THE ANTEBELLUM PERIOD
During the first part of the nineteenth century, state charters were individually constructed and issued by the state legislatures. In 1828 the New York State legislature enacted a general banking law that set uniform regulations for all banks that received legislative approval. This legislative approval was abandoned in 1838 with the enactment of a free banking law.
The free banking reforms appear to have come in two distinct waves: 1837-1845 and 1850-1853. In the first wave, four states enacted some form of free banking legislation: Michigan, New York, Georgia, and Ohio. Between 1850 and 1853, eleven more states enacted free banking laws and, by 1860, seventeen of the twenty-eight antebellum states followed New York's lead by eliminating legislative approval and enacting free banking laws. The free banking laws, however, did not preclude the legislatures' issuing charters. In fact, many of the free banking states continued to issue charters, thus establishing a dual banking system. …