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TopWhy Do Banks Branch?
Financial intermediaries, banks included, collect funds from savers and reallocate them to fund users. Financial intermediation involves gathering customer information and monitoring loan performance. These activities carry real costs and risks. A portion of the transaction cost is associated with distance and location (Brevoort & Wolken, 2009). Retail banking customers (individuals and small and medium-sized firms) are attached to specific locations. Thus, banking market information is location-specific and retail banking services are local in nature (Hannan & Prager, 2001) contributing to geographic fragmentation and location-based sub-markets.
To bridge fragmented markets, banking institutions with a branch office structure emerge as a solution. Placing offices in various locations enables banks to tailor their services to local conditions. At the same time, branch offices are overseen by the head office to ensure institutional integrity. Multi-location and multi-market banking also allows banking institutions to grow in size, providing benefits such as sharing bank reserves, economies of scale, and geographical diversification in portfolios and customer base (Carlson & Mitchener, 2006; Wheelock, 1992). Studies confirm that the branch banking system promotes competition and weeds out weaker banks, which helps make the banking system as a whole less prone to banking crisis than the unit banking system (Carlson & Mitchener, 2006; Wheelock 1992).