Access To Credit And Stock Market Participation

Access To Credit And Stock Market Participation by SSRN

University of Michigan, Stephen M. Ross School of Business

April 15, 2015

Ross School of Business Paper No. 1276

Abstract:

We exploit staggered removals of interstate banking restrictions to identify the causal effect of access to credit on households’ stock market participation and asset allocation. Using micro data on retail brokerage accounts and proprietary data on personal credit histories, we document two effects of the loosening of credit constraints on households’ financial decisions. First, households enter the stock market by opening new brokerage accounts. Second, households increase their asset allocation to risky assets and reduce their allocation to cash, consistent with a lower need for precautionary savings. The effects are stronger for younger and more credit constrained investors. Overall, we establish one of the first direct links between access to credit and households’ investment decisions.

Access To Credit And Stock Market Participation – Introduction

At the forefront of an ongoing debate in consumer finance is the effort to promote competition among financial institutions and facilitate households’ access to credit. This regulatory effort has fueled one of the largest transformations of the banking sector in recent history—the relaxation of geographic restrictions on bank expansion across state lines. As a result, the financial sector has been transformed from a system of highly fragmented regional markets to an integrated market with interstate banking.

We study how this transformation of the banking sector has affected households’ financial decisions. We focus on two key decisions: stock market participation and asset allocation. This focus is motivated by several factors. First, a household’s market participation and asset allocation are the most important drivers of long-term wealth. Second, stock market participation has significant implications for asset prices. For example, prior work establishes a direct link between stock market participation and the equity premium (e.g., Campbell 1993 and Heaton and Lucas 1999). Third, stock market participation is important for the macroeconomy, serving as an important driver of aggregate investment.

To study the effect of access to credit on market participation, we exploit the staggered passage of interstate banking laws, which permit the entry of large national banks—the primary issuers of personal credit cards and other forms of unsecured credit—into select geographic markets. These laws have several useful properties for identification. First, because the laws are specific to each state pair, they generate sharp temporal variation in the timing of a state’s deregulation with the states that house the primary issuers of credit cards. Second, because many laws require reciprocity, they become effective not when the law is passed by the state permitting bank entry, but when the reciprocal law is passed by the other state in the pair. Third, the passage of these laws is often determined by the internal politics inside the state parliament (Kroszner and Strahan 1999), a factor plausibly exogenous to a household’s investment opportunity set.

Using proprietary data on personal credit from TransUnion and a comprehensive panel of all bank branches in the U.S., we show that the relaxation of interstate banking restrictions leads to an immediate entry of large national banks into the deregulated states and a 34% increase in the annual number of new credit card issuances in these states within the first two years. Next, using the increase in credit cards instrumented by the passage of interstate banking laws, we establish our main finding: access to credit increases stock market participation.

Using administrative data from a national discount brokerage, we find that a one percentage point increase in credit card issuances (instrumented by interstate banking laws) leads to a 32 bps increase in the number of new brokerage accounts and a 38 bps increase in the number of new brokerage clients. The entire increase in market participation is concentrated within the first two years after the deregulation and levels off thereafter. Combined with the estimated increase in credit card issuances attributable to banking deregulation, our evidence suggests that stock market participation increases by 13% over the first two years after a state removes legal barriers to interstate banking.