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Statements to the Congress.

I am pleased to have this opportunity to appear before this subcommittee on behalf of the Federal Reserve Board and to discuss issues related to bank mergers in the United States. However, I am not in a position to discuss issues or to answer questions directly related to the proposed BankAmerica-Security Pacific merger--which I understand is the subject of these hearings--because that merger is under consideration by the staff, preparatory to presentation to the Board of Governors.

As you know, the U.S. banking system is in the midst of a major restructuring in response to a variety of forces in the marketplace and the continuing removal of legal barriers to entry by the individual states. A substantial volume of bank mergers has been a natural response to the changing banking environment. The Board is very aware of this evolution but is equally aware of its statutory responsibility to manage events so as to preserve competition and ensure a safe and sound banking system for the benefit of consumers, businesses, and taxpayers.

My testimony will discuss recent structural changes in the banking system, the Federal Reserve's continuing efforts to ensure that competition is maintained, and some of the potential benefits that may be expected from the restructuring of the banking industry that is currently under way. In my brief remarks today, I will not address specifically two other areas of Board concern--bank safety and soundness and Community Reinvestment Act issues. Both of these areas were covered, however, in Governor LaWare's testimony of last fall, which I understand you already have.



The restructuring of the banking industry accelerated in the past decade. There were 188 mergers of healthy banks involving about $9 billion in acquired assets in 1980, 710 such mergers involving $131 billion in acquired assets in 1987, and an estimated 550 mergers of healthy banks with $60 billion in acquired assets in 1989.

Such an increase in merger activity did not come about spontaneously. It was instead a natural response to the removal of many longstanding legal restrictions on entry that had, until recently, balkanized the banking industry, not only between states but within states as well. As recently as 1985, only eighteen states allowed statewide branching, but by early 1992 only four states prohibited statewide banking. In 1985, only nine states permitted interstate banking, but by early 1992, only two states prohibited banking operations by out-of-state banks.

As the banking industry has responded to the changing environment, mergers have not been the only source of structural change. Indeed, the banking industry has been characterized by a great deal of entry and exit that is indicative of a very healthy, active competitive environment. For example, while there were approximately 5,000 acquisitions of healthy banks during the 1980s, about 2,700 new banks were formed, 16,000 new bank branches were opened, 6,600 branches were closed, and about 1,100 banks failed.

After a decade of remarkable changes in the banking industry, and with a major restructuring of the industry under way, almost no change has occurred in the concentration in local banking markets, the battlefield on which competition is measured and analyzed. The fact that concentration in both urban and rural banking markets has remained largely unchanged during the past decade is an indication of the continuing intensely competitive structure of the banking industry. This structure reflects, in part, the efforts of the regulators to ensure a competitive banking environment. That concentration has not increased, especially in urban markets, is even more notable because in many of these markets banking concentration could increase considerably without raising any questions about competition under the antitrust laws or the merger guidelines of the Justice Department.



In view of the apparent success of the regulators in ensuring a competitive banking environment, I would like to discuss briefly what the Federal Reserve does to carry out its responsibilities for evaluating the competitive effects of mergers.

Each and every bank merger or acquisition subject to the Board's jurisdiction--that is, those mergers involving member banks and all acquisitions by, and mergers of, bank holding companies--are reviewed for the possibility of anticompetitive effects. The review process begins at one of the twelve Federal Reserve Banks. At this stage, the appropriate geographic market for analyzing the merger is determined. This determination may involve the collection of data on commuting, shopping patterns, banking relationships and so forth. If such data prove to be insufficient, telephone surveys may be conducted and, if necessary, on-site visits made by Federal Reserve staff to conduct interviews.

Once the appropriate geographic area that encompasses the local banking market is determined, an initial screening analysis is conducted. This analysis essentially involves calculating basic pre-merger and post-merger measures of market structure (market shares and the Herfindahl index) to determine whether the proposed merger would be acceptable under the merger guidelines of the Justice Department. If these guidelines are not breached, the application is approved at the Reserve Bank and the process goes no further. However, structural measures that exceed the merger guidelines are taken as an indication that the merger may have anticompetitive effects, and Board review is required. The reason I say that a merger that exceeds the merger guidelines may have anticompetitive effects is that, although market structure is important, it is only one factor that may influence competition in banking.

For cases submitted to Board review, other factors are analyzed that would not need to be examined if the basic commercial bank concentration ratios imply competitive structures. These factors include the following: (1) the importance of nonbank thrift institutions as commercial bank rivals, especially with respect to their newer lending and checking powers; (2) the importance of potential competition, both in terms of the likelihood of new entry into the market and the current competitive effect from the threat of entry; (3) the importance of other depository and nonbank financial institutions, such as credit unions and finance companies, in the market; (4) the financial health of the target firm; (5) the economic health of the market (to determine whether exit from a declining market is necessary marketplace adjustment); and (6) the competitive importance of the target bank if the target has proved to be an unusually weak competitor.

This brief overview of procedures for the competitive analysis of merger proposals at the Federal Reserve suggests the seriousness with which the Federal Reserve takes its responsibility for ensuring competition in banking.

The Federal Reserve's bank merger policy and past actions discourage the filing of merger applications that would clearly be anticompetitive. The self-screening of such cases means that the vast majority of merger proposals submitted to the Board do not raise any competitive issues. Furthermore, in some of the relatively few cases in which a merger application does raise competitive problems, the Federal Reserve will accept a divestiture of the merged bank's offices in local markets when competition may otherwise be harmed. Such divestitures eliminate the anticompetitive aspects of the merger while allowing the basic merger to proceed. Thus, the Board accepted divestiture proposals in thirty-five merger cases from 1982 to 1991. The rationale for such a policy is to ensure that competition is maintained in local markets while government interference with the marketplace in our private-property-based system is minimized. That is, if there are no competitive or other public policy problems arising from a merger, no reason exists to impede decisions in the marketplace, whether or not clear public benefits are evident. This issue of public benefits brings me to the last point I would like to discuss--the potential for public benefits from bank mergers.


Possible public benefits from a merger are considered under the "convenience and needs" test and may be used to override some of the anticompetitive elements that may exist in a given merger application. If, for example, a target bank is expected to fail, the benefit to the community of uninterrupted banking servicesvices, the continued operation of convenient offices, and possibly the maintenance of some employment may provide the basis for approving the merger in spite of some anticompetitive effects.

During the past few years, poor operating performance and the increasingly competitive environment have caused many banks, as well as other firms, to focus a great deal of attention on increasing their efficiency. Banks, like other firms, must be efficient to be profitable; equally important, they must be profitable to be healthy.

Researchers, bankers, and bank consultants all agree that some banks are much more efficient than others and that opportunities exist to increase the overall efficiency of the industry. Many bankers believe that mergers provide an important vehicle for achieving significant efficiency gains, particularly from merging large, sophisticated back-office and computer operations and from closing redundant offices. Or mergers may provide the environment necessary to justify the tough cost-cutting measures that are required.

The historical evidence indicates that there have been few efficiency gains from past mergers, but these studies have been based on mergers from an era in which banks were almost surely less cost conscious. Today, bankers, like other business managers, know that if they are to remain competitive they must carefully manage their costs. Thus, the future may hold a potential for more cost savings than research has demonstrated to date. Moreover, the possibility of efficiency gains may be greater in some cases than in others. Thus, the Board carefully considers the potential for these gains on a case-by-case basis. In the last analysis, however, regardless of any anticipated efficiency gains, the Board is sensitive to its statutory responsibility to maintain competitive banking markets.

Let me conclude by emphasizing that the Board is aware of, and is monitoring, the changes that are taking place in the financial system. It continues to devote substantial efforts to the analysis of the competitive effects of all proposed mergers and acquisitions. Although we at the Board have not yet seen systematic evidence of efficiency gains from mergers, the potential for substantial cost savings clearly exists. Thus, we continue to research this topie because of the possibility of important public benefits in this area, not the least of which is that a safe and sound banking system is also a profitable one.
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Title Annotation:Edward C. Ettin testimony concerning bank mergers
Publication:Federal Reserve Bulletin
Article Type:Transcript
Date:Apr 1, 1992
Previous Article:Statements to the Congress.
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