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Trends in banking structure since the mid-1970s.

Trends in Banking Structure since the Mid-1970s The structure of the American banking system has changed significantly since the mid-1970s. Over the period from 1977 to 1987, the number of banking organizations has declined considerably, while the share of banking assets controlled by the largest banking organizations has increased sharply. At the same time, banks have expanded beyond their traditional geographic borders; differences between commercial banks and nonbank financial institutions have diminished; and the number of bank mergers and acquisitions has soared. The factors responsible for these developments are still at work and will likely lead to continued rapid change in banking structure.

Recent structural change in the banking industry is of interest for at least three reasons. First, changes in costs attributable to changes in bank size may affect the operating efficiency of banks and, in turn, their profitability, and the prices, quality, and convenience of the services they offer. Second, theory and empirical evidence suggest that changes in banking structure and entry conditions may affect the degree of competition for financial services. As in nonfinancial industries, the degree of competition in banking also influences profitability and the prices of services offered by firms. Finally, concern over potential changes in the structure of the banking industry historically has stimulated debate over the consequences of increases in aggregate concentration of economic resources in banking.

Because of the extensive recent changes in banking structure and the important issues that such changes raise, it is timely to examine the causes and significance of these developments. The first section of this article discusses the causes of the major structural changes that have occurred in banking over the past decade. The later sections analyze data describing these changes at the national, regional, state, and local levels.

CAUSES OF RECENT CHANGES IN BANKING STRUCTURE Recent changes in banking structure have been made possible by two primary developments: (1) recently enacted legislation has allowed banking organizations to expand geographically; (2) legislative and regulatory changes have facilitated mergers and acquisitions among banking organizations located in the same geographic area.

Legislation Affecting Geographic Expansion by Banks Legislation relaxing constraints on the geographic expansion of banks and bank holding companies has come principally from the states.(1) This legislation has substantially increased opportunities for bank expansion both within states and across state lines. The legislation itself has been spurred by a number of forces, including technological changes in making it easier to make loans and gather deposits from distant customers, the attempts of regulators to arrange takeovers of an increasing number of failing and troubled banks, efforts by state authorities and local business and community groups seeking to attract capital into a state, and the desires of the banking industry itself.

The states that have passed legislation allowing increased instrastate and interstate geographic expansion of banking organizations in the 1970s and 1980s are listed in the box. As indicated, intrastate expansion can occur either through bank branching or by multibank holding company acquisition or expansion. Since 1970, the number of states that reduced branching restrictions has grown markedly, rising from 6 during the 1970s to 22 during the 1980s. As a result, 35 states currently allow unlimited statewide branching or statewide expansion through acquisition of existing banks. Eleven states allow only limited branching, but two of these have passed legislation that will permit statewide branching in the future. Only four states remain unit banking states, allowing no branching.

The easing of restrictions on the intrastate expansion of multibank holding companies permits banking organizations to expand statewide by chartering separate banks under one holding company. Thus, expansion through multibank holding companies can be accomplished even in states where branching is limited or prohibited. The number of states that liberalized constraints on multibank holding company expansion grew from 3 in the 1970s to 11 in this decade. Missisippi is the only state that has not enacted a law allowing statewide operation of multibank holding companies. Since Mississippi allows statewide branching, however, this restriction on holding companies does not limit geographic expansion.

The passage of laws allowing insterstate banking has had an even more dramatic effect on banking structure than has the widespread liberalization of intrastate banking laws. The McFadden Act (1972) and Section 3(d) (the "Douglas Amendment") of the Bank Holding Company Act of 1956 limit the expansion of national banks by making them subject to state limitations on geographic expansion. Since the 1970s, all but five states have passed laws permitting the acquisition of state-chartered banks by out-of-state banking organizations. Given the application of federal laws, these revised state laws also open federally chartered banks to acquisition by out-of-state bank holding companies. With the exception of one passed in Maine in 1975, all state laws governing interstate banking have been enacted since 1982. Although a majority of state laws still limit entry to banking organizations from nearby states, some states are beginning to permit entry on a nationwide basis.

Legislative Changes Affecting Local Market Structure Changes in the structure of the banking industry at the local level have historically been limited by antitrust laws. However, during the 1980s the implementation of these laws changed with the passage of legislation that reduced the differences between commercial banks and nonbank financial firms.

In applying antitrust laws to the banking industry, courts have traditionally defined banking markets to include only banks from local geographic markets. This approach, which excluded nonbank financial firms from banking markets, reflected concern over the limited number of institutions that provided financial services to consumers and small business, and the fact that banks were the only institutions that offered such unique and widely used products as demand deposits and commercial loans. Consequently, antitrust laws generally deterred large institutions in the same local area from merging and held intact the basic structue of the banking industry.

Legislation allowing nonbank depository institutions to compete more directly with banks has altered the effect of antitrust laws. In 1980 and 1982, Congress expanded the investment powers of thrift institutions and also permitted them to offer transactions accounts that are functionally equivalent to demand deposits. These changes allowed savings and loans and savings banks to offer many of the products that traditionally had been available only from banks. As these institutions have taken advantage of the new powers, the composition of their balance sheets has become more like that of banks, although substantial differences remain.

Federal and state legislation also has reduced the differences between banks and various nondepository financial firms. At the federal level, legislation phased out interest rate ceilings on most bank accounts beginning in 1980 and permitted interest-bearing transactions accounts throughout the country. In 1982, banks were allowed to issued insured money market deposit accounts. These changes came in response to high inflation and interest rates in the late 1970s and the subsequent movement of funds out of the banking system. They allowed banks to offer deposit interest rates that were competitive with those of money market mutual funds, which were then growing rapidly. At the state level, legislation was passed that went beyond federal laws in expanding the range of activities open to banks and other financial institutions. Some states, for example, granted banks broader securities powers and others permitted banks to offer real estate or insurance services that even today are not allowed by federal regulators.

The U.S. Department of Justice and federal banking agencies have responded to new banking legislation in part by modifying antitrust policies. As thrift institutions were granted expanded powers, regulators began to include them, either wholly or partially, in local markets for banking services. By including additional firms in a local market, the market share of each bank in that market is reduced, and thus fewer bank mergers raise antitrust concerns. Moreover, the reduction of differences between banks and nondepository financial intermediaries has prompted the Justice Department to relax guidelines governing mergers among banking organizations. The guidelines, which specify those acquisitions te Justice Department likely would challenge as anticompetitive because of their effect on concentration, now are more liberal for banking than they are for other industries.

In the evolving competitive and regulatory environment, banking organizations have been eager to take advantage of the new opportunities to merge with, or acquire, other banks. The number of bank mergers and acquisitions since the mid-1970s has risen to a historically high level(2). One reason for increased merger and acquisition activity may be the belief that larger size or a greater variety of products will lower costs or increase consumer satisfaction. Past empirical studies of bank costs have generally found little evidence linking size and efficiency, but they cannot measure possible increases in consumer convenience. In addition, because detailed cost data are available mainly for small banks and for only a few large banking organizations, most cost studies have focused on small banks.

Banks also may merge and acquire for reasons other than perceived cost savings. They may do so in response to acquisitions by rival firms, increases in the perceived size of geographic markets, or the desire of managers to provide convenient service in all parts of their markets. Mergers and acquisitions also may reflect banks' attempts to obtain diversification benefits that stem from geographic expansion or to better position themselves for increased competition from other financial institutions. Finally, by increasing firm size, mergers and acquisitions may serve the function of raising the compensation of bank managers. Currently, however, no consensus exists among observers of the banking industry on the relative merits of these explanations.

Overall, during the 1980s, legislative and regulatory changes have cuased banking organizations to increase significantly their geographic coverage and the range of products they offer. The sections that follow discuss the structural changes that accompanied these developments.

AGGREGATE STRUCTURAL CHANGE Aggregate banking structure can be measured either by the number of banking organizations or by the relative size of these organizations as reflected in the concentration of banking assets.

Number of Banks and Banking Organizations While deregulation has had a major effect on some elements of U.S. banking structure, it has had little effect on the number of insured commercial banks(3). Between 1976 and 1987, the number of banks declined 4 percent, from 14,399 to 13,753(table 1). The number of commercial banks has declined at a faster pace in the past two years, possibly foreshadowing a longer-term trend; but, as recently as 1985, there were slightly more banks than in 1976.

The relative stability in the number of banks resulted from a robust pace of formation of new banks that largely offset an otherwise strong movement within the banking industry toward greater consolidation. From 1976 through 1987, nearly 2,800 banks were chartered -- an average of 252 per year. The number of new banks formed each year trended upward until 1984, when it peaked at 400.

Exit by banks from the industry typically occurred either because of failures or through mergers and subsequent conversions to branches. More than four-fifths of the banks that left the industry since 1976 were converted into branches of other banks. Bank failures, however, soared during the mid-1980s to reach 184 in 1987(4). Although many factors contributed to these failures, most involved small banks whose loan portfolios were concentrated in weak sectors of the economy, such as agriculture or energy. Of the 654 banks that have failed since 1976, only 41 percent actually ceased operations. Most failed banks were acquired by other institutions as part of purchase-and-assumption transactions under the supervision of the Federal Deposit Insurance Corporation(5).

In contrast to the relatively stable number of commercial banks, the number of banking organizations has declined more than 17 percent since 1976, or more than four times the rate of decline for banks (table 2). As used here, the term "banking organinzation" includes all bank holding companies and independent banks, that is, banks not affiliated with holding companies.

Most of the decline in the number of banking organizations came about through acquisitions by multibank holding companies. Such acquisitions enabled these companies to double the number of banks under their control from 2,296 in 1976 to 4,465 in 1987 and contributed to a dramatic decrease of 59 percent in the number of independent banks (table 2)(6). These acquisitions also significantly changed the distribution of assets among types of banking organizations. (1) The only recent federal legislation affecting the geographic expansion of banks was the Depository Institutions Amendments of 1982 (the "Garn-St Germain Act"). This act permitted a limited amount of interstate baning by allowing acquisitions of large failing banks by out-of-state banking organizations. So far, it has been used rarely. (2) The number of bank mergers grew gradually from 135 in 1976 to 188 in 1980. It then jumped 91 percent to 359 in 1981, marking the beginning of a period of accelerated consolidation. Bank mergers totaled 422 in 1982, 432 in 1983, and 553 in 1984, before falling to 472 in 1985, the most recent year for which data are available. (3) The number of banking organizations is smaller that the number of commercial banks because banks that are part of the same holding company are consolidated to determine the number of discrete banking organizations. Banks owned by the same holding company are counted separately in determining the number of commercial banks. (4) In 1988, the number of bank failures rose to 200. (5) Under a purchase and assumption, the FDIC arranges the sale of a failed institution as a means of protecting depositors' funds. In such transactions the acquiring institution typically assumes all the liabilities of the failed institution, but only purchases those assets whose value has not been impaired. Ownership of the lower-quality assets usually falls to the FDIC. (6) The decrease in the number of independent banks also reflects growth of one-bank holding companies that resulted from independent banks converting to a holding company structure. Such conversions are frequently undertaken to broaden the range of services that a banking organization can provide or to enlarge the geographic region that it may serve through its nonbank subsidiaries. Also, holding companies sometimes are used to provide leverage capacity beyond that available to a bank or to reduce tax payments. Despite these factors, conversions of independent banks to one-bank holding companies have no immediate effect on the total number or relative size of banking organizations and thus do not affect the structure of the banking industry. In 1976, insured domestic banking assets were distributed almost evenly among multibank holding companies, one-bank holding companies, and independent banks, with each group controlling about one-third of all banking assets. By 1987, multibank holding companies had increased their share of assets to 70 percent; one-bank holding companies held 21 percent of total assets; and banks not affiliated with holding companies controlled only 9 percent.

The emergence since the 1970s of multibank holding companies as the dominant type of organization has greatly affected the size distribution of firms in the industry. Because the average size of banking organizations was affected significantly over this period by an increase in total banking assets, real growth in the economy, and the inflationary conditions of the time, data for 1987 are presented in terms of both nominal asset values and values deflated by the cumulative change in total domestic banking assets since 1976. The adjusted data are used to indicate changes in the relative sizes of banking organizations.

Comparing adjusted data for 1976 and 1987 reveals that banking organizations continue to exhibit significant diversity in size. Small organizations remain numerically dominant; however, the number of such institutions and the share of assets they control has declined. The only size category to show an increase in either the number of companies or their asset share is that with assets between $5 billion and $25 billion. To a large extent the increase in this size category reflects the recent rise of large regional and "superregional" organizations, the vast majority of which are multibank holding companies.(7) Many of these firms have pursued particularly aggressive acquisition strategies that were made possible by the dismantling of barriers to intrastate and interstate banking. Such acquisitions have reduced the number of small companies and given rise to larger organizations. Many regional and superregional institutions also have been able to sustain growth rates in excess of industry norms in large part because of their location in areas of the country--especially the Northeast and Southeast--where the economy has grown relatively rapidly.

Aggregate Concentration of Banking Assets As the size of banking organizations increased, overall asset concentration within the industry rose significantly. In 1976, assets were heavily skewed toward the largest organizations: the top 1 percent of the organizations controlled 53 percent of total assets. By 1987, the share belonging to the top 1 percent had grown to 62 percent. In comparison, the proportion of assets accounted for by organizations in the 90th through the 98th percentiles--institutions with assets between $166 million and $2 billion--declined from 26 percent to 23 percent. The share controlled by the group of banking organizations below the 90th percentile, which comprises those with domestic banking assets of less than $166 million as of year-end 1987, fell from 21 percent to 15 percent.

Analyzing changes in the share of domestic banking assets held by the 100 largest banking organizations helps to indicate more clearly where the greatest amount of concentration within the industry has occurred. The composition of the top 100 corresponds closely to that of the top 1 percent of all banking organizations discussed above. The 100 largest organizations by and large are multibank holding companies, each of which has combined domestic banking assets exceeding $2 billion.

The growth in assets controlled by the 100 largest banking organizations varied significantly depending on the size of the organization. However, little of this increase was attributable to the largest institutions. The 10 largest organizations in that group actually suffered a decline in their percentage share as loan problems at several money center banks and the exclusion of New York institutions from regional compacts enacted by several states worked against an increase in their relative holdings. The share of assets held by the banking organizations ranked 11 through 25 rose from 11 percent to 15 percent. However, the largest increases belonged to banking organizations ranked 26 through 100, whose share of assets grew from 18 percent to 27 percent. Included in this group of institutions are many of the previously mentioned regional and superregional organizations that have grown rapidly in recent years.

Comparisons with earlier periods and with data from other economic sectors show that concentration in the banking industry over the 1976-87 period appears to have increased significantly. The percentage of total domestic banking assets controlled by the top 1 percent of banking organizations between 1960 and 1975 changed less than 1 percent; from 1976 to 1987, however, the share increased 9 percent. By comparison, recent evidence from the manufacturing sector as a whole shows virtually no change in the level of aggregate concentration.(8)

The use of domestic banking assets to measure firm size may understate the degree of concentration that exists within the industry. If all assets, domestic and foreign, of U.S. chartered banks are counted, the share of assets controlled by the top 1 percent of banking organizations is 67 percent rather than 62 percent. The difference reflects the large foreign loan exposures of money center institutions. If off-balance-sheet assets and assets of nonbank subsidiaries of bank holding companies were also added, the level of concentration would increase even further, since few small organizations engage in transactions that generate off-balance-sheet assets or have significant amounts of nonbank assets.(9) Regardless of which of these asset measures is used, however, the overall trend toward sharply higher aggregate concentration in commercial banking since the mid-1970s remains significant.

At least two factors, however, may mitigate the significance of increased aggregate concentration. First, banks and other financial firms now often compete more directly, thereby reducing the ability of any one banking organization or group of organizations to dominate a market for deposits, loans, or other financial services. Second, since the mid-1970s, assets held by domestic banking organizations have declined relative to those of other financial institutions that have a large percentage of their assets in loans. The rapid growth of assets at U.S. branches of foreign banks suggests that competition has increased between American banks and banks chartered in foreign countries. Only mutual savings banks have grown more slowly than domestic banks. As a result, the share of financial institution assets held by domestic banking organizations fell from 58 percent in 1976 to 50 percent in 1987.(10) The decline in part reflects the shift of prime corporate customers from the bank loan market to other credit markets, such as commercial paper.(11) Regardless of the reasons for the decline, however, the diminished role of banking organizations within the financial services sector of the economy may lessen the significance of higher levels of aggregate concentration in banking.

REGIONAL STRUCTURAL CHANGE Changes in banking structure at the regional level have had important effects on the aggregate structure of banking. Regional banking structure grew in importance with the lifting of state restrictions on interstate banking. However, even before states began to liberalize interstate banking laws, banking organizations were able to circumvent restrictions on geographic expansion to a limited extent. A few companies were allowed by the Bank Holding Company Act of 1956 to continue operating in states in which they were already present. Some banking organizations also expanded nationwide by establishing loan production offices and nonbank subsidiaries, such as consumer finance and mortgage banking companies. In the past decade, an array of technological advances, including electronic funds transfers, loan sales, and automated teller machine transactions, has provided banking organizations with still other means of extending their reach beyond state borders. However, none of these forms of circumventing restrictions on interstate banking broadened the ability of banks to expand geographically to the extent that the passage of interstate banking laws did.

One measure of the effect that laws permitting interstate banking have had on bank structure is the number of interstate mergers of banking organizations that has occurred during the 1980s. Before 1983 no merger of banking organizations in which both of the firms had deposits of more than $1 billion had ever taken place across state lines. Since then, there have been 34 such mergers. Collectively, interstate mergers of banking organizations with more than $1 billion in assets account for 47 percent of all mergers of that size that were consummated over the 1980-87 period. The number of interstate mergers rose dramatically following the Supreme Court's 1985 decision affirming the constitutionality of regional interstate compacts.

The extent of interstate banking can also be gauged from the volume of banking assets in a state controlled by out-of-state organizations. In 20 states, at least 20 percent of banking assets are owned by out-of-state institutions. In Arizona, Connecticut, Idaho, Maine, South Carolina, and Washington, more than 45 percent of domestic banking assets are controlled by out-of-state firms.(12)

The adoption of laws permitting expansion across state borders began slowly. Indeed, even after Maine acted, interstate banking was not addressed legislatively in other states until 1982. Since then, the number of states that permit interstate banking has grown steadily and, at year-end 1987, stood at 45.

In general, states that passed legislation later in the period adopted more liberal forms of interstate banking legislation. Initially, several states, including South Dakota and Delaware, passed relatively restrictive laws that permitted out-of-state banks to acquire or establish only "limited purpose" banks that specialized in certain well-defined activities, such as credit card processing. Later, many states adopted laws permitting entry on a reciprocal basis to full-service banks from out of state; that is, out-of-state banks were allowed to enter a state and offer a complete range of banking services provided that a reciprocal arrangement was extended to that state's own banks. Such laws, which have been passed by 33 states including those with the most banking assets, are currently the most popular form of interstate banking legislation. When specifically crafted to include only contiguous states or states located in the same region, reciprocal laws have resulted in so-called regional compacts.

The formation of regional compacts has had a significant effect on the structure of the banking industry. The data show that over the 1976-87 period, most regions recorded substantial consolidation in terms of both declining numbers of banking organizations and rising levels of concentration as measured by the share of domestic banking assets accounted for by the ten largest banking organizations. Of the regions, the Northeast and Southeast registered large declines in the number of organizations and the greatest increases in concentration. These areas pioneered interstate banking and include those states that formed especially long-lasting and distinct compacts. It is within these regions that many superregional institutions, whose interstate mergers and acquisitions have had such a significant effect on national levels of concentration, are located.

In the Midwest and Middle-Atlantic regions, the number of organizations also declined precipitously, but changes in concentration ratios have been much smaller. These changes apparently reflect bank failures and the acquisition of small banks by a few large, multibank organizations within individual states. The West is the only region where the number of banking organizations rose, and the level of concentration declined. The shrinkage of assets at large banking organizations and a continued robust rate of bank formations in California appear to be behind these developments in the West.

In recent years, reciprocal legislation has increasingly been superseded by even more liberal laws that allow unconditional entry by out-of-state banks on a national basis. Thus far, twelve states have adopted or established "trigger" dates for such legislation.(14) It is not yet clear whether banking organizations will take advantage of the opportunity to expand nationwide or just continue their recent pattern of expansion into nearby states. However, legislation permitting nationwide banking creates at least the potential for substantial increases in concentration by allowing more money center and superregional banking organizations to merge.

STRUCTURAL CHANGE AT THE STATE LEVEL Changes in banking laws governing intrastate expansion also contributed importantly between 1976 and 1987 to consolidation of the banking industry. As with interstate banking legislation, state branching laws since the mid-1970s have become increasingly liberal, as evidenced by the growth in the number of states that permit statewide branching. Statewide branching now exists in 34 states and the District of Columbia in contrast to 1976 when just 21 states permitted it.

More liberal branching laws have affected banking structure in several respects. Without exception, the states with the highest levels of concentration permit statewide branching. Those with more restrictive forms of branching have substantially lower statewide concentration ratios.(15)

More liberal branching laws also contributed to a proliferation of bank branches. Over the 1976-87 period, the number of bank branches rose from 33,027 to 46,314, in large part reflecting the acquisition and subsequent conversion of banks to branches by multibank holding companies and the establishment of new branches. As the number of acquisitions leading to branch conversions rose, levels of statewide concentration also generally increased. Between 1976 and 1987, nearly four-fifths of the states experienced some increase in concentration as measured by the share of domestic banking assets belonging to the five largest firms.

7. In this article, "superregional" denotes a banking organization with at least $10 billion in assets that has banking subsidiaries in more than one state.

8. Aggregate concentration in the manufacturing sector typically is expressed in terms of share of value added by the largest firms. Over the 1962-82 period, the share of value added by the 100 largest firms increased only 1 percent. The share of value added by the 200 largest firms rose just 3 percent over the same period.

9. Data on off-balance-sheet assets are reported by multibank holding companies and one-bank holding companies with more than $150 million in total assets. The data do not encompass all of the types of off-balance-sheet activity in which banks now engage; however, even available data give some indication of the extent to which such assets are heavily concentrated among the largest banking organizations. As of year-end 1987, for example, loan commitments, standby letters of credit, commercial letters of credit, swaps, and foreign exchange contracts totaled about $3 trillion, of which the 50 largest bank holding companies accounted for $2.8 trillion. Similarly, nonbank subsidiary assets of the 50 largest bank holding companies amounted to $134 billion as of year-end 1987, compared with a total of $149 billion for all multibank holding companies and one-bank holding companies with more than $150 million in assets.

10. Comparing balance sheets across firm types is problematic because balance sheets of different types of financial institutions differ in many respects. However, use of different measures would not change the conclusion that banks were smaller relative to other financial institutions in 1987 than they were in 1976.

11. Between 1976 and 1987, commercial paper outstanding increased from $52.0 billion to $373.6 billion, for a compound annual growth rate of 19.6 percent.

12. Although only 34 percent of domestic banking assets in Texas are held by out-of-state organizations, Texas ranks first in the absolute level of assets controlled by outside firms. This position results in part from acquisitions of failing banks under the Garn-St Germain Act rather than solely from acquisitions under state legislation.

13. Regions are defined in the table to reflect as closely as possible reciprocal enabling legislation adopted by the staes; but because the manner in which states have defined regions is not uniform, definitions of regions are to some degree arbitrary. Assets belonging to multibank holding companies are assigned to regions based on the location of branches and subsidiary banks rather than on the location of the parent organization.

14. Notwithstanding the trend toward more liberal interstate banking laws, several states have either retained or introduced caps on the percentage of state banking assets that can be held by any one banking organization.

15. Other factors besides branching laws affect banking concentration at the state level. The largest increase in statewide concentration occurred in South Dakota (27 percentage points), New Jersey (26), New Hampshire (22), Florida (22), and Texas (20). Besides changes in intrastate branching laws, several other factors contributed to the higher concentration in these states. The dramatic rise in the level of concentration in South Dakota has been due primarily to state legislation enabling a few large out-of-state banks to set up credit card and insurance operations. The special nature of these operations limits the importance of the change in state concentration. Expansion of multibank holding companies along with liberalized branching laws contributed to higher levels of concentration in New Jersey, New Hampshire, Florida, and Texas. Of the states with decreases in concentration, Delaware recorded the largest change: entry into that state by several out-of-state holding companies that formed limited-purpose banks accounted for most of this decrease. As in South Dakota, the establishment of these firms has had little effect on other Delaware banking organizations.

CONCENTRATION IN LOCAL BANKING MARKETS Although the structure of the banking industry at the national, regional, and state levels lately has received increased attention, most interest in banking structure traditionally has focused on local markets for banking services. These markets have typically been defined to cover relatively small areas, in many cases no larger than metropolitan areas or counties. Although recent technological developments allowing banking services to be provided by mail, telephone, and automated teller machine have led many to argue that local markets as traditionally defined are overly restrictive, studies of the behavior of individuals and small businesses suggest that the market for some basic banking services continues to be geographically limited. For this reason, in antitrust cases, courts and regulators generally continue to use local banking markets to focus on changes in the level of concentration in banking.

Increases in local banking concentration, it is believed, might reduce competition among providers of banking services. When antitrust regulators or the courts examine competition in a local banking market because a proposed merger appears to raise a serious competitive issue, a great deal of information on the distribution of bank customers, commuting patterns, advertising patterns, and other dimensions of economic integration is taken into account so that the geographic extent of the market can be accurately determined. However, in empirical analyses using a national cross-section of banking markets, such detailed definitions are not feasible. As a result, these analyses usually measure urban banking markets by Metropolitan Statistical Areas (MSAs) and rural banking markets by non-MSA counties. For local markets defined in these ways, market concentration can then be measured by the percentage of market deposits held by the three largest banks in the market. The average market concentration ratios presented here follow this convention.(16)

The national average of three-firm concentration ratios for the years 1976 to 1986 for all urban and rural banking markets in the United States. Contrary to the results reported for aggregate concentration, average local market concentration has been quite stable. For urban markets, the average three-firm concentration ratio fell from 68.5 in 1976 to 65.8 in 1982, before reversing trend and rising to 67.5 in 1986. Rural markets followed a similar, but even more muted, trend, with the average concentration level falling from 90.1 in 1976 to 89.4 in 1982, before rising to 89.5 in 1986. For both urban and rural markets, average market concentration decreased in most states over the period. Twenty-two states had increases in average urban market concentration while 28 had decreases. Average concentration in rural markets rose in 15 states and fell in 33. Breaking the decade into two five-year periods, decreases in concentration were much more prevalent over 1976-81 than over the decade as a whole, with only six states having increases in average local market concentration for urban and rural banking markets. In contrast, over the 1981-86 period, about two-thirds of the states saw increases in average concentration in urban banking markets, while states were split evenly between increases and decreases in concentration in rural markets.

The point in time at which the trend toward lower local concentration ceases coincides with the passage of federal legislation in 1980 and in 1982 that allowed increased competition between banks and other financial institutions and led to the easing by antitrust authorities of restrictions on local bank mergers and acquisitions. On the other hand, increased competition for banks from other financial institutions as a result of these legislative changes should alleviate anti-trust concerns about the slight upward trend since 1982 in local market concentration. The change in trend in local concentration also coincides with widespread adoption of interstate banking laws. These laws increase the possibility of entry into local banking markets by banking organizations operating elsewhere. The potential for entry does not directly affect the structure of local banking markets. However, it may increase competition among firms already in the market and induce such firms to set lower prices to inhibit entry. Even discounting these sources of increased competition, changes in local market concentration are much smaller than, and often in the opposite direction of, those observed at the state, regional and national levels.

CONCLUSION Since the mid-1970s, the U.S. banking system has become significantly more concentrated at the national, regional, and state levels, though not on the local level. Nationally, decreases in the number of banking organizations and dramatic increases in concentration have occurred principally due to the growth of very large regional and superregional bank holding companies, often through merger or acquisition. Changes in regional and state concentration vary, with the Northeast and Southeast showing the greatest increases. Four-fifths of the states recorded increases in concentration over the past decade, but the extent of the increase varied widely. Concentration in local banking markets decreases slightly over the 1976-82 period, with smaller increases occurring since then.

These structural changes can be traced in large part to relaxation of legal restrictions on the geographic expansion of banking organizations and on the products they can offer. The enactment of interstate banking laws in 45 of the 50 states and increased concentration at the state level helped bring about increases in national and regional concentration. These increases occurred in part because interstate banking laws allowed the development of fast-growing superregional and regional bank holding companies. At the state level, increases in concentration can be tied to more liberal branching laws adopted in the past decade.

While legislative and economic changes have led to increased concentration among banking organizations, they have also allowed increased competition between banks and other financial institutions. Greater competition for banks from thrift institutions and other firms and the lack of any substantial increase in concentration at the local level should mitigate antitrust concerns raised by structural changes.

(16). The three-firm concentration ratio is commonly used in analyses of local banking markets because the number of firms included in a concentration ratio should be proportionate to the size of the area being examined. In the case of local markets, including more than three firms in a concentration ratio would result in high levels of concentration in almost all markets.

Local market concentration is measured using deposits rather than assets because asset data are available only at the firm level, while deposit data can be disaggregated by local geographic area.
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Author:Amel, Dean F.
Publication:Federal Reserve Bulletin
Date:Mar 1, 1989
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