Investigating the Banking Consolidation Trend

Abstract

Lately, the U.S. commercial banking industry has been consolidating.Although some firms have left the industry, many more have simply combined with other firms, resulting in fewer, bigger banks.Many legislators, regulators, bankers, and economists have roundly applauded this consolidation trend.In their view, consolidation is a laudable market response to industry changes that will bring significant benefits such as greater efficiency and a lower rate of bank failures.They also see consolidation as an effective way to shift resources out of banking, an industry they think is plagued with excess capacity.We take exception to this widely held positive view of consolidation.After examining the available evidence, we do not think consolidation will deliver any of the benefits its proponents expect from it.That's because consolidation in banking does not appear to be primarily due to market forces.Although we cannot definitely explain why this trend is occurring, the data suggest that a major cause is incentives created by government policy.In fact, our investigation raises serious questions about the wisdom of certain bank regulatory practices.* Also, Adjunct Professor of Finance, University of Minnesota. 1 A high proportion of failed banks are absorbed by healthy banks under the Federal Deposit Insurance Corporation's (FDIC's) purchase and assumption option.The acquiring bank purchases some of the assets and assumes the deposits and other liabilities of the failed bank.The acquiring bank may also pay a premium to the FDIC representing in part the value of the failed bank's charter.

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