Financial Regulation and Development purpose, particularly the data collection work on the bank balance sheets of Warren E. Weber at the Federal Reserve Bank of Minneapolis (Rolnick and Weber 1983; Weber 2003, 2006), which were complemented with additional data on tax introduction years and policy characteristics. In this case, while we can follow the balance sheet composition and profitability, there is no information on branching. However, this is only partially a problem, because branch-opening may only be one instrument through which financial development occurs, and as long as we register an increase in deposits, which is observed, this points to the mechanism presented in this model.

We contribute to three established bodies of literature, building a simplified model of banking (Freixas and Rochet 1997) with reduced-form maturity mismatch (Diamond and Dybvig 1983) and bank liquidity choice (Allen and Gale 2000). First, this paper contributes to the literature on financial inclusion, showing that policies that promote safe assets can drive branch expansion. From a theoretical perspective, Townsend and Zhorin (2014) present an innovative framework to evaluate the trade-offs that banks face in branch installation in emerging market countries, with a special focus on geography and industrial organization. A series of applied papers have highlighted the political and economic reasons for branch expansion (Assuncao, Mityakov, and Townsend 2012; Keniston et al. 2012) and its effects on poverty, firm growth, and competition (Beck, Demirguc-Kunt, and Maksimovic 2004, 2005; Burgess and Pande 2005; Burgess, Pande, and Wong 2005). Second, we join the literature on the incentive perspective of banking regulation. Besley and Ghatak (2013), Dewatripont and Tirole (2012), and Fahri and Tirole (2012) all discuss financial regulation and/or special bank taxation as a device to counterbalance implicit bailouts, to achieve optimal managerial discipline, and to balance large-scale maturity mismatch. These conclusions are in line with the work of Kashyap, Rajan, and Stein (2008), who propose the replacement of capital requirements with a mandatory holding of government bonds. On an analogous line, Calomiris and Gorton (1991), Calomiris (1999), and Calomiris and Mason (2003) highlight the trade-off between the public finance costs of safety nets and the gains from panic elimination. Although we do not introduce a formal macroeconomic model, we also offer an argument to reconcile the radically partitioned literature on the relation between financial regulation and the macroeconomy. Roubini and Sala-i-Martin (1992, 1995), Pagano (1993), and King and Levine (1993) support a limited regulation of financial intermediation, because this would lower equilibrium growth through a lower saving rate, fewer resources for investment, less risk diversification, and screening of entrepreneurs. On a critical stance, after a cross-country empirical assessment, Dornbusch and Reynoso (1989) argue that “the beneficial effects of removing financial regulation remains open to challenge”. While, on the entire opposite side of the spectrum, Stiglitz (1994) defends financial regulation as a growth-enhancing force, because by artificially lowering interest rates, it improves borrowers’ incentives, reinforces firms’ equities, and creates capital scarcity. In our work, we find that both views can be right and indeed financial regulation can be either welfare-enhancing or detrimental, depending on the magnitude through which it is implemented.

In Section 1, we present the essential theoretical framework, describing first the economic environment and then investigating the bank decision problem. In Section 2, we discuss empirical evidence 6