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.