provided by Research Papers in Economics
ESSAYS ON ISSUES
THE FEDERAL RESERVE BANK
FEBRUARY 2000
OF CHICAGO
NUMBER 150
Chicago Fed Letter
Mergers and the changing
landscape of commercial
banking (Part II)
In a recent Chicago Fed Letter, I exam-
ined the motivations for, and the con-
sequences of, the tremendous wave of
U.S. bank mergers during the 1980s
and 1990s.1 In that document I reached
three main conclusions. First, I argued
there is little evidence of any systemat-
ic reduction in competition in retail
banking or small business financing
markets as a result of the bank merger
wave. Although the largest commercial
banks have a much more prominent
national position today than 20 years
ago, these banks’ shares of local banking
markets have not increased materially.
Second, I suggested that the current
bank merger wave is showing signs of
maturing. A number of commercial
banks have achieved nationwide or
near-nationwide geographic coverage,
and as additional banks attain this
geographic scope the demand for
large market extension mergers will
naturally diminish. Furthermore, the
rapid development of the Internet
and e-commerce may allow banks to
replace, or at least complement, their
merger-based growth strategies with
internal growth via electronic distribu-
tion of financial services. Since Part I
was written, the Financial Institutions
Modernization Act (FIMA) of 1999
abolished the historical separation
of commercial banking, investment
banking, and insurance underwriting.
This long-awaited development will
likely dampen the bank merger wave
further, as acquisitive banks shift their
focus—and their scarce acquisition
capital—away from purchasing other
banks and toward purchasing insurance
companies and securities firms.
Third, I indicated that from our van-
tage point at the end of the 1990s,
it may be too early to evaluate the
eventual competitive implications of
the bank merger wave. If fully success-
ful, the electronic delivery of retail
and wholesale banking services may
make the notion of “local” banking
markets obsolete. To the degree that
this happens—and to the degree
that large banks can limit the entry
and/or the mobility of small banks in
electronic markets—the increasing
national market shares of large com-
mercial banks may have more serious
competitive implications than is gen-
erally thought.
In this Fed Letter, I discuss the prospects
for small commercial banks in a post-
merger-wave banking industry in which
electronic delivery of financial services
becomes commonplace. In such a
world, should we expect “branchless”
delivery of financial services to be
dominated by a few large banks, or
will the advent of electronic banking
markets provide important strategic
opportunities for small banks? I pro-
pose a simple conceptual framework
for thinking about this question, a
framework that considers the strate-
gic advantages and disadvantages of
increased bank size.
Local versus national
banking markets
Between 1980 and 1998
the share of domestic de-
posits held by the nation’s
ten largest commercial
banks nearly doubled.
Large banks achieved
this growth primarily by
making market extension
mergers, which change
the ownership of the
acquired bank without
affecting the structure
of local banking markets.
As seen in figure 1 (which
is reprinted here from
Part I of this Fed Letter),
the national market
shares of large banks increased mark-
edly during the bank merger wave but
the concentration of local banking
markets remained stable. Hence, by
traditional measures of market struc-
ture, 20 years of bank mergers had lit-
tle adverse impact on competitive
conditions in U.S. commercial bank-
ing markets.
But these structural changes occurred
during the traditional “brick and mor-
tar” banking paradigm, in which most
retail banking and small business
banking services were provided by lo-
cal banks in local markets. Today, a
growing number of household and
business customers access account in-
formation, transfer funds, pay bills,
make trades, and apply for loans elec-
tronically, without ever setting foot in
a branch office. The banking industry
may be in the midst of a paradigm shift,
in which electronic delivery channels
and automated lending technology will
increasingly allow out-of-market banks
to compete for retail and small busi-
ness customers without establishing a
physical presence in the local market.
No one knows for sure how electronic
delivery channels will ultimately alter
the banking landscape, but some
1. National and local market structure
10...................1,750
1980 ’82 ’84 ’86 ’88 ’90 ’92 ’94 ’96 ’98
Note: HHI = sum of squared market shares of all banks in market.
Source: Board of Governors of the Federal Reserve System.