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June 2009
Banking Institution Mergers: Frequently Asked Questions
Q: What is behind the wave of mergers in the banking industry?
A: Several economic factors have caused banking institutions to merge over the past several years. These factors include:
- Greater efficiency. Banks often are able to operate more cost effectively by increasing their size. The costs of many functions don't double when the scale of operation doubles. As a result, mergers are one way to keep costs and prices down.
- Leveraging technology. Banks and their customers have become increasingly accustomed to the advantages of new and expensive technologies. Many of these technologies are too expensive unless costs can be spread over a large number of customers. Mergers are often necessary to allow banks to introduce and maintain the technologies customers increasingly demand.
- Changing laws. Laws which had prevented many banks from operating in more than one state recently have been removed or overridden. The advent of interstate banking and branching means more opportunities for banks operating in different states to merge with each other.
- Diversification. One effective method of controlling risks inherent in bank lending is to diversify operations across different geographic regions and different types of customers. Mergers can help diversify such risks.
- Broader array of products. Mergers may give banking institutions an opportunity to offer a broader array of services. A merger of two banks with different expertise can result in a combination more to the liking of customers looking for one-stop shopping.
Q: What are "in-market" mergers?
A: An in-market merger is one that takes place between two banks operating in the same geographic area, typically a city or metropolitan area. The merged institution often ends up with more than one branch in the same neighborhood and as a result may close overlapping offices. All mergers whether within a market or not result in some redundancies, and therefore present opportunities to save costs by eliminating certain internal systems or merging some products and services.
Q: How competitive is the market for banking services?
A: With more than 8,000 banks and thrifts in the U.S., banking is one of the most competitive industries in the world. Consider the following characteristics of the American financial services marketplace:
- There are more banks per citizen in the U.S. than in any country in the world.
- There are nearly four times more deposit-taking institutions in the U.S. than in the 15 nations of the European Union, Switzerland, Canada and Japan combined.
- More than 7,900 credit unions, 5,000 securities brokers, 2,500 mortgage companies and 1,500 finance companies today vie for consumers' business.
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Q: Have mergers affected competition?
A: Federal Reserve data show that measured on the local level, where competition takes place, markets have actually experienced more banking competition, not less, in the past decade.
Q: Are there safety and soundness implications of mergers?
A: No. All mergers require regulatory approval and are subject to intense examination by regulators. If anything, the effect on safety and soundness is generally positive, as mergers allow banks to operate more efficiently, with greater services available to their customers and greater diversification of risks. |
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Q: How do mergers affect communities?
A: When a locally controlled bank is merged into a bank headquartered elsewhere (an out-of-market merger), some apprehension about the institution's future commitment to the local community is bound to result. However, because such mergers generally are motivated by a bank's desire to gain access to a new market, commitment to the community often is actually enhanced. Banks, aware that merger transactions focus public attention on their role in the community, frequently demonstrate their commitment immediately through greater lending activity. Banking regulators monitor both the statements of commitment made by institutions at the time of a merger or acquisition, as well as banks' performance under the Community Reinvestment Act, which requires banks to serve all parts of the community.
Q: How do mergers affect small businesses?
A: According to a recent study by Federal Reserve and Wharton Financial Institutions Center economists, not a great deal. Their analysis revealed that acquisitions don't appear to be associated with a significant reduction in small business lending by the participating banks. And in those cases in which there is some reduction, it appears to be offset by the positive reaction of other banks in the same local market. Most banks view the period immediately following a merger transaction as the most intensely competitive, as competing lenders try to win small business relationships away from the merging institution.
Q: How do mergers affect consumers?
A: The effects mergers have on consumers vary widely. There may be some inconvenience and anxiety when a customer's bank or branch is acquired. The issuance of new account numbers and new checks is a familiar hassle. Sometimes the types of accounts change, or even the schedule of fees. Banks are aware of these issues and most go to great lengths to try to retain customers during these periods of transition.
Q: What effect have mergers and acquisitions had on a customers access to branches?
A: A branch closing which has resulted from a merger need not necessarily mean a lost relationship. The reason a branch closes is usually the presence of a nearby branch of the same bank. Moreover, the number of bank and thrift branches has increased each year since 1993. Today there are more than 99,000 bank and thrift offices in the U.S. |
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Q: What effects have mergers had on fees assessed for retail bank services?
A: The impact is not clear. Market conditions and the level of competition often determines the cost for retail bank services.
Q: Do mergers result in layoffs?
A: Overall employment in the banking industry actually has increased slightly over the last five years. Some mergers do result in layoffs. However, many banks reduce their staff largely through attrition to ease the transition (e.g., 40-percent annual turnover rates are not unusual among tellers).
Q: How has the merger activity in the past decade affected the concentration of assets in the banking industry?
A: Over the last decade, the number of commercial banks declined by one third and the average asset size nearly doubled as banks acclimated themselves to deregulation, technological change, and new market pressures. Currently, the fifty largest bank holding companies hold approximately 68 percent of all commercial bank assets compared to 55 percent in 1990.
Q: Have the large bank holding companies increased their market share at the expense of smaller institutions?
A: No. A study conducted by the Federal Reserve Bank of New York reveals that the rise in the concentration of assets is primarily due to external growth through mergers and acquisitions, implying that the increased concentration "reflects a transfer of banks assets as ownership changed through consolidation, rather than internal growth of existing subsidiaries." Thus, the key motivation behind the rise in merger activity in the 1990s was the removal of excess capacity rather than an effort to use competitive advantage to expand existing operations.
| Q: Do mergers encourage the formation of new banks?
A: Yes. The rise in the number of new banks in the second half of the 1990s coincides with a surge in merger activity in the same period. A study conducted by the Federal Reserve Bank of Kansas City suggests that new bank formation is positively related to prior merger activity. The study further points out that a higher rate of new bank formation is more strongly related to mergers when ownership shifts away from small organizations to large ones or toward distant organizations. |
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Q: What is in store for banking consolidation?
A: Merger activity is a natural process by which companies make themselves more efficient and better able to compete for customers. The banking industry is no exception. Regulators also keep a check on future consolidation by exercising their approval authority over mergers and acquisitions banking transactions are unique in the thoroughness of the review they undergo. Transactions that could result in high levels of concentration are denied or approved on the condition of disposition of certain branches or other offices in order to promote competition.
Q: What is the Hirfindahl-Hirschman Index?
A: The Hirfindahl-Hirschman Index, or HHI, is the standard measure used by economists to evaluate market concentration. The greater the level of concentration among competitors, the higher the HHI. The HHI runs on a scale from zero (representing extreme competitiveness) to 10,000 (representing monopoly). The HHI is determined by squaring (multiplying by itself) the market share of each firm in a market, and then adding up the results. The example below illustrates this calculation.
Example Calculation for a Hypothetical Market With HHI of 2,000
| Competitor |
Market Share % |
HHI |
| Bank #1 |
29 |
841 |
| Bank #2 |
24 |
576 |
| Bank # 3 |
19 |
361 |
| Bank # 4 |
10 |
100 |
| Bank # 5 |
10 |
100 |
| Bank # 6 |
4 |
16 |
| Bank # 7 |
2 |
4 |
| Bank # 8 |
1 |
1 |
| Bank # 9 |
1 |
1 |
| Total Market |
100 |
2,000 |
(Hirfindahl-Hirschman Index Source: Federal Reserve)
Questions? Please contact Keith Leggett, (202) 663-5506 for more information.
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