SEPTEMBER 2004

Merger Activity in the U.S. Banking Industry

A recent Federal Reserve Bank of San Francisco Economic Letter examines the increase in large bank interstate merger activity in the United States. In 2004, the mergers of Bank of America with FleetBoston and J.P.MorganChase with Bank One will create institutions with more than $1 trillion in assets each—joining Citigroup as the only trillion dollar banking organizations in the U.S. Various regulatory changes and economic factors have contributed to the trend in large bank mergers (that is, mergers in which both the target institution and acquiring institution hold more than $1 billion in total assets). In addition to creating enormous firms, in terms of assets, the new institutions will serve markets that span many states. The Economic Letter posits that these "mergers will continue to shape the structure of the banking industry in the U.S. ...[and] may signal the beginning of a process for building a truly national banking franchise."

The 1997 amendments to the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 established a comprehensive federal statutory scheme permitting interstate branching by state and national banks. The number of large bank mergers peaked in 1998, but the key characteristic of the mergers since 1997 has been that the majority of these deals "...involved institutions headquartered in different states ...[suggesting] that these are market-expansion mergers, where the acquirer and target have few overlapping operations in their respective banking markets." Another recent regulatory change was the passage of the Gramm-Leach-Bliley Act (GLBA) in 1999 that allowed banks to expand their services to include securities and insurance activities. By clearing away regulatory impediments, the Riegle-Neal Amendments Act (RNAA) and GLBA contributed to changes in the economic conditions in the U.S. banking industry. By consolidating individual state charters into one charter, the RNAA allows banking organizations to enjoy the economies of scale that derive from "streamlining management and operations." By expanding the range of financial products that banks are allowed to offer, GLBA promotes economies of scope which occur when "...the joint costs of producing two complementary outputs are less than the combined costs of producing the two outputs separately." Geographic expansion and product expansion contribute to risk diversification. Therefore, the institutions created by large bank interstate mergers are better insulated from economic shocks that might occur in any one geographic or product area.

The U.S. banking industry currently enjoys "...record profits and relatively low volumes of problem loans." Given the benefits to large bank interstate mergers outlined above and the fact that recent "megamergers" involve healthy target and acquiring institutions, what are the implications of a U.S. banking industry characterized by trillion dollar institutions with the possibility of operating in all 50 states? The Economic Letter suggests that antitrust concerns are the first hurdle that bank mergers must clear. In examining the effect on competition resulting from a merger, banking regulators scrutinize local banking markets. Divestitures result from "an unacceptably high level of concentration in local banking markets." National-level concentration is limited as well. The Riegle-Neal Act prohibits deals producing institutions that control over 10 percent of the total amount of deposits in insured U.S. depository institutions. Without even operating in all 50 states, the Bank of America/FleetBoston "...organization would control about 9.9 percent of the national deposit share..." As more mergers create institutions that approach the cap, policymakers will likely be asked to ease the constraints of current law. Policymakers will also need to address the systemic risk posed by banks that are considered "too-big-to-fail." An increase in megamergers creates more of such banks and requires policymakers to strike a balance "...promoting economic efficiency while safeguarding the nation's financial system."