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Federal Reserve Bank of San Francisco
Working Paper Series
Does regional economic performance affect bank health? New analysis of an old question
Mary C. Daly
John Krainer
Jose A. Lopez

The idea that regional economic performance affects bank health is intuitive and broadly consistent with the aggregate banking data. That said, micro-level research on this relationship provides a mixed picture of the importance, size, and timing of regional variables for bank performance. This paper helps reconcile the heterogeneous findings of previous research by: (1) employing a unique “composite measure” of regional economic performance that combines several regional indicators into a single index; (2) constructing bank-specific measures of regional economic conditions, based on bank deposit shares, that account for banks’ presence in several states; and (3) estimating models for all banks and intra- and inter-state banks separately. Empirical results based on this bank-specific composite regional measure point to a tractable link between regional economic performance and bank health. The importance of regional variables holds for both intra- and inter-state banks. Out-of-sample forecasts indicate that the composite index also helps tie down the relative riskiness of bank portfolios across states. Finally, although interstate banks do seem to diversify away some of their portfolio risk, our analysis suggests it is too soon to conclude that interstate banks are immune from regional influences.

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Mary C. Daly & John Krainer & Jose A. Lopez, Does regional economic performance affect bank health? New analysis of an old question, Federal Reserve Bank of San Francisco, Working Paper Series 2004-01, 2003.
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Keywords: Banking market ; Bank capital
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