Review of Industrial Organization 12: 59–78, 1997.
1997 Kluwer Academic Publishers. Printed in the Netherlands.
Determinants of Entry and Proﬁts in Local Banking
DEAN F. AMEL
and J. NELLIE LIANG
Financial Structure Section, Federal Reserve Board, Washington D.C., 20551, U.S.A.
Abstract. This paper estimates a two equation model of market entry and proﬁts, utilizing data on
entry into over 2,000 banking markets over the period 1977–88. The entry equations measure whether
entry depends on incumbent ﬁrms’ proﬁts and other market attributes that reﬂect the long-term
attractiveness of markets for entry. Market proﬁts, assumed to follow a partial-adjustment process,
are affected by entry directly and indirectly through market structure. The model also corrects for an
unavoidable source of error in market-level proﬁts for the banking industry. The estimates suggest that
a competitive process is at work in banking markets that limits the ability of supra-normal proﬁts to
persist. Entryis morelikelyin marketsthat have highproﬁts, consistent with previous empirical results
that market structure adjusts more quickly when proﬁts are supra-normal. Population and population
growth are also strong determinants of entry. Entry, in turn, reduces proﬁts in rural markets.
Key words: Entry banking, branching, potential competition.
Economic research has long recognized that entry is a key element of the competi-
tive process (e.g., Bain, 1956, and Sylos-Labini, 1962). In recent years, efforts have
been made to incorporate the effects of entry on economic behavior into empir-
ical research through the development of dynamic models of markets. Dynamic
models examine explicitly the competitive process by which entry and expansion
by existing ﬁrms work to reduce above-normal proﬁts. Most empirical tests of the
dynamic effects of entry on market behavior have looked at changes in market
concentration as a proxy for entry (e.g., Amel and Liang, 1990; Geroski, Masson,
and Shaanan, 1987), but not at entry directly. Studies that have estimated entry (and
exit) equations often measure entry by the net change in the number of ﬁrms over
long periods of time, rather than noting the timing of actual entry into a market.
This paper examines whether a competitive process limits the persistence of
above-normal proﬁts in local geographic banking markets by applying a dynamic
model of entry and market performance to banking markets. It estimates directly
Economist, Board of Governors of the Federal Reserve System. The authors have beneﬁted from
extensive discussions with James Berkovec and from comments by Timothy Hannan, Christopher
James, Daniel McFadden, Stephen Rhoades and seminar participants at the University of Maryland
and the Federal Reserve Board. Thanks are due to Ken Cavalluzzo and Ben Takahashi for excellent
research assistance and to Steve Bumbaugh for initial construction of the data set.