BANKS RESPONSES TO DEREGULATION - PROFITS, TECHNOLOGY, AND EFFICIENCY

The deregulation of interest rates in the early 1980s raised bank fund ing costs and lowered profits. In response, banks raised fees for depo sit services, reduced branch operating costs, and shifted to higher ea rning assets. Rates of return did not regain their prederegulation lev els until the early 1990s. Our goal is to decompose the change in bank profits following deregulation into (i) internal, bank-initiated adju stments to the new regulatory structure and (ii) external, contemporan eous changes in banks' business environment. This decomposition will d epend, in part, on the assumed competitive structure of the banking in dustry. With perfect competition, output and input prices are part of the external environment and banks' responses are limited to changes i n output and input quantities. An alternative approach assumes imperfe ct competition where banks have some control over output prices (depos it fees, minimum balance requirements, and interest rates on certain l oans) and output quantities and input prices comprise the external env ironment. The alternative model is supported by the data. Using this m odel, large banks-but not smaller banks-are found to have relied prima rily on changing output prices and input use to mitigate and reverse t he negative effects of deregulation on profits. The adjustment to dere gulation was essentially complete after four years. Following this, ad ditional changes in bank profitability (during the late 1980s) were pr imarily due to changes in banks' business environment.