Product differentiation and efficiencies in the retail banking industry

- We estimate a discrete choice demand model with endogenous entry to evaluate the socially efficient market outcomes.
- We find no evidence for under- or over-entry.
- We find a moderate welfare loss under free entry due to banks entering into the wrong location in product space.
- We find significant welfare loss if banks are homogeneous.

We empirically quantify the welfare implications of bank entry in the United States between 2000 and 2008. We use a fully structural framework that combines a differentiated demand model with an endogenous product model to investigate the market outcomes. We find no evidence for under- or over-entry. Compared with the socially efficient outcome, there is a mild welfare loss resulting from banks entering wrong locations in product space. Compared with the observed outcome, consumer surplus drops by 20-38% and bank profits decline by 48-59% when banks are homogeneous. Therefore product differentiation significantly improves welfare under free entry.