How To Reform the Bank Merger Process

The U.S. banking industry looks very different today than it did just a few decades ago. Gone are the days when most banks were small, local institutions that primarily interacted with customers at physical bank branches. The industry has transformed into one in which just a handful of megabanks control hundreds of billions—and in some cases trillions—of dollars in assets, while thousands of bank branches across the country have closed in recent years. Notably, the national market share for deposits of the largest 10 banks in the United States increased dramatically from 16.8 percent in 1995 to 51.3 percent in 2020. In other words, the banking industry has become significantly more consolidated around fewer, larger firms.

While a number of factors can account for this development—such as the rise of the internet and legislative changes made by Congress in the 1990s that loosened restrictions on the banking industry—one of the most important causes is that federal regulators have approved mergers to create megabanks not previously seen in the United States. Over just the past half-decade, the federal banking agencies (FBAs) have approved the mergers of E*Trade and Morgan Stanley, BB&T and SunTrust, and PNC and BBVA to create what are now the sixth-, ninth-, and 10th-largest bank holding companies, respectively, in the United States. While these banks’ potential impacts on financial stability have increased with their larger footprints, it is unclear what financial services these merged holding companies—with consolidated assets of between $541 billion and $1.1 trillion—can offer that their pre-merger components could not.

Perhaps recognizing that the creation of these giant institutions may pose systemic risk concerns while not benefiting the communities that they serve, the Federal Deposit Insurance Corp. (FDIC) in March issued a request for information on the bank merger review process. The agency noted, “Significant changes over the past several decades in the banking industry and financial system necessitate a review of the regulatory framework that applies to bank merger transactions.”

This column explores how bank mergers can harm the communities they serve as well as the economy and outlines several steps for federal regulators to consider to improve the merger review process.

Bank mergers can harm communities and the economy

Modernizing the review process is of critical importance because of the demonstrably negative consequences for consumers that can stem from bank mergers. Some mergers have resulted in lower interest rates paid on deposits, meaning that potential depositors may instead invest in riskier assets in a search for yield or simply may not save for the future. Loans are also fewer, smaller, and higher-priced when banks consolidate, which can stymie small-business creation and job growth. When banks become larger, they tend to forgo relationship banking with small businesses and individuals in their communities. Mergers of community banks with regionals or nationals can result in slowing small-business formation, commercial real estate development, and new construction, as well as in increasing unemployment and income inequality. Significantly, the creation of so-called bank deserts due to the closure of physical bank branches can have extremely negative effects on the communities served.

Additionally, the consolidation of the banking industry into fewer, larger firms poses a threat to the stability of the financial system and economy. One of the lessons of the 2008 global financial crisis is that the existence of too-big-to-fail banks creates systemic risk. Research has shown that the failure of a large bank would cause more harm to the economy than the failure of five smaller banks with combined deposits equal to those of the larger bank. This risk essentially requires the federal government to bail out too-big-to-fail firms in the event of financial stress, creating an implicit subsidy that benefits large firms at the expense of their smaller competitors.

Recommendations for updating the bank merger review process

The Bank Merger Act of 1960 prohibits the three FBAs—the Federal Reserve, the Office of the Comptroller of the Currency (OCC), and the FDIC—from approving mergers that are expected to have these harmful results. The statute requires the FBAs to review a potential merger’s effects on competition; whether the merger meets the “convenience and needs” of the community; risks to the stability of the U.S. financial system; and the financial and managerial resources of the merging banks. Congress’ explicit inclusion of each of these factors in the law makes it clear that the bank regulators can block a merger on any of these grounds—for example, if they find that a proposed merger would not benefit the communities served. However, the observed consequences of previously approved mergers are inconsistent with the statute, and scholars have found that the FBAs inappropriately overrely on measurements of a merger’s competitive effects and at times perform only “perfunctory” analyses of many the other factors.

In order to ensure that bank merger reviews appropriately achieve Congress’ goals as laid out in the Bank Merger Act, the authors propose the following steps, among others, for the FBAs to consider:

• The FDIC should weigh in on every bank merger adjudicated by the OCC and the Fed—including those that involve existing large regional banks or would create new ones.
• The FBAs should adopt a rebuttable presumption of denial for mergers of banks with more than $100 billion in assets or if the newly merged institution would have more than $100 billion in assets, indexed to inflation.
• The FBAs must develop and adhere to bright-line standards throughout the review process, such as for determining whether merged banks will be both well managed and well capitalized and whether a merger would threaten financial stability.
• The FBAs should establish a presumption that proposed mergers do not benefit the public and require banks to provide quantifiable estimates as to how proposed mergers will affect their communities.
• The FBAs should look at the markets for specific product lines being offered by banks—such as residential mortgages, personal and small-business loans, and digital payments services—and whether the merger of two institutions would negatively affect the community’s access to those products.
• The U.S. Department of Justice and the FBAs should lower the Herfindahl-Hirschman Index standard set by the 1995 Bank Merger Competitive Review guidelines—which regulators use to screen the competitive effects of mergers—such that a potential increase in the index would require a more thorough review of a merger.

Taking these steps would make the bank merger process more thorough and decrease the chance that bank mergers that pose risks to their communities or financial stability would be approved.

Conclusion

Congress’ decision to include several factors, including the needs of the community, into the merger review process is a recognition of the unique and essential role that banks play in the financial system. Concentration has become a predominant feature of the banking industry with negative consequences for consumers, and regulators must not continue to allow mergers to occur completely unabated.

This column is based on a recent CAP comment letter, which can be found here.