We develop a model of banking industry dynamics to study the relation between commercial bank market structure, business cycles, and borrower default frequencies. We analyze an environment where a small number of dominant bank interact with a many small competitive fringe banks. A nontrivial size distribution of banks arises out of regional segmentation and endogenous entry and exit. The model is calibrated to match a set of key aggregate and cross-sectional statistics for the U.S. banking industry. We test the model against business cycle moments, salient characteristics of the commercial bank distribution and the empirical regularities linking banking crisis, default frequencies and concentration. As in the data, the model generates countercyclical loan interest rates, bank failure rates, default frequencies, and markups as well as procyclical loan supply and entry rates. The model also generates the observed negative relation between loan return rates, variance of returns and net interest margins with bank size. We find that the model is consistent with the empirical literature in generating a negative relation between banking crisis and concentration as well as a positive relation between default frequencies and concentration. Finally, the model is used to study the effects of bank competition and the benefits/costs of policies to mitigate bank failure.
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