FDIC Banking Review Consolidation in the U.S. Banking Industry: Is the “Long, Strange Trip” About to End? by Kenneth D. Jones and Tim Critchfield *
In 1995, the Brookings Institution published a paper
entitled “The Transformation of the U.S. Banking Industry: What a Long, Strange
Trip It’s Been.”1 Using a breathtaking array of facts and figures,
the paper described in great detail the dramatic changes that had occurred in
the U.S. commercial banking industry over the 15 years from 1979 to 1994. The
banking industry was transformed during that period, according to the paper (p.
127), by “the massive reduction in the number of banking organizations; the
significant increase in the number of failures; the dramatic rise in
off-balance sheet activities; the major expansion in lending to U.S.
corporations by foreign banks; the widespread adoption of ATMs; . . . and the
opening up of interstate banking markets.” The paper went on to explain that
most of these major changes in banking could be traced to two developments: (1)
the extraordinary number of major regulatory changes during the period, from
deposit deregulation in the early 1980s to the relaxation of branching
restrictions later in the decade; and (2) clearly identifiable innovations in
technology and applied finance, including improvements in information
processing and telecommunication technologies, the securitization and sale of
bank loans, and the development of derivatives markets. Other research would
later confirm the paper’s assessments and its explanation of the course of
events in the banking industry over the period 1979–1994.
Yet, nearly a decade after the publication of that
paper, data indicate that the transformation of the banking industry is ongoing
and that the number of banking organizations continues to decline—though
recently there have been signs that the number of organizations is beginning to
stabilize. In fact, when we take a closer look at the data, we find that the
rate of decline in the number of banking organizations appears to be slowing
markedly. Indeed, if the data from the past few years indicate anything about
future direction, the rate of decline can be expected to slow even more over
the next five-year period. Moreover, some evidence suggests that this slowdown
in the rate of decline might presage a return to a relatively stable population
of banking organizations. Such a result would be in sharp contrast to
conventional wisdom—which foresees continued consolidation of the banking
industry in the United States.
Because this paper is part of a collective review of the
U.S. banking industry’s past and an anticipation of its future, many aspects of
the industry’s transformation are discussed in companion papers.2
Our focus, therefore, is primarily on industry structure: how it has already
changed and how it might evolve in the future. Accordingly, we begin with an
updated review of the structural changes that occurred in the industry over the
two decades 1984–2003. This should give us a better understanding of the scope
of the decline that has taken place. We then review the causes of this decline
and the literature on how the decline has affected such things as asset
concentration, banking competition, efficiency, profitability, shareholder
value, and the availability and pricing of banking services. After this
analysis of the past, we offer some projections of future banking industry
of Structural Change in the
U.S. Banking Industry 1984–2003
Over the two decades
1984–2003, the structure of the U.S. banking industry indeed underwent an
almost unprecedented transformation—one marked by a substantial decline in the
number of commercial banks and savings institutions and by a growing
concentration of industry assets among a few dozen extremely large financial
institutions. This is not news. As mentioned above, the decline in the number
of banking organizations has been ongoing for more than two decades and has
been well documented in the literature.3 Nevertheless, a brief
overview will serve to clarify both the scope of the decline and the increasing
concentration of assets among the nation’s largest banking organizations.4
At year-end 1984, there were 15,084 banking and thrift
organizations (defined as commercial bank and thrift holding companies,
independent banks, and independent thrifts).5 By year-end 2003,
that number had fallen to 7,842—a decline of almost 48 percent (figure 1).
Distributed by size, nearly all the decline occurred in the community bank
sector (organizations with less than $1 billion in assets in 2002 dollars), and
especially among the smallest size group (less than $100 million in assets in
2002 dollars).6 Yet the community banking sector still accounts for
94 percent of banking organizations (figure 2).
Geographically, the decline in the number of banking
organizations appears to have been remarkably uniform across a variety of
regions and markets. Critchfield et al. (2004), for example, examined the
decline of community banks across four market segments—rural markets, small
metropolitan markets, and suburban and urban parts of large metropolitan
markets—and found that the declines across all four markets were proportionally
similar (figure 3). The dynamics underlying the declines, however, differed
depending on the market. Rural areas, for example, saw proportionally fewer
mergers and very little de novo entry in comparison with both small and large
metro markets, where a larger number of mergers was partially offset by a
larger number of new-bank start-ups.
Overall, the bulk of the decline in the number of
organizations between year-end 1984 and year-end 2003 was due to unassisted
mergers and acquisitions (see figure 4, which decomposes the net change in the
number of banking organizations into several components).7 In every
year but one, mergers and acquisitions were the single largest contributor to
the net decline in banking organizations.8 During the entire
period, 8,122 individual bank and thrift organizations disappeared through
unassisted mergers and holding company purchases.
From 1985 through 1992, though, failures also
contributed significantly to the decline in the number of banking organizations
(figures 4 and 5). Of the 2,698 bank and thrift closings caused by failure
during the entire period 1984–2003,9 almost 75 percent of them
occurred in the five years 1987–1991, when failures averaged 388 per year.10
In contrast, from 1994 to 2003 only 66 institutions failed—a figure that
reflects greatly improved economic conditions and stronger safety-and-soundness
decline caused by mergers, acquisitions, and failures was partially offset by
the entry of 3,097 new banking organizations between year-end 1984 and year-end
2003. This number is remarkable, given the overriding downward trend. During
the entire period, the number of de novo bank entrants averaged 163 per year,
even though the creation of new banks was suppressed at the height of the
thrift and banking crises. The number of start-up institutions peaked in 1984,
then declined each year until 1993; then, as economic conditions improved and
more capital became available, de novo entry into the banking industry resumed
and continued through the end of the century. With the beginning of an
economic recession in March 2001, the number of new charter formations again
As indicated by the trends in mergers, acquisitions, and
failures on the one hand, and start-ups on the other hand, the pace of the
decline in the number of banking organizations has not been uniform. Indeed,
graphing the rate of change reveals a very strong cyclical pattern, with
declines occurring at a rate that increased in the 1980s, only to slow in the
1990s (figure 6). Since 1992 the rate of decline in the number of institutions
has trended consistently lower. (This pattern has important implications for
our projections of the structure of the industry.)
At the same time that the number of banking
organizations was decreasing, industry assets were increasing. Over the
1984–2003 period, banking industry assets grew from $3.3 trillion to $9.1
trillion—a increase of nearly 70 percent in real terms.11 Existing
assets and asset growth, however, were not evenly distributed across the
industry but, instead, were becoming more and more concentrated among the
nation’s largest financial institutions. This trend can be seen in figure 7,
which compares asset share over time for each of five size groups during our
period. The asset share of the largest size group—organizations with more than
$10 billion in assets—increased dramatically, rising from 42 percent in 1984 to
73 percent in 2003. In contrast, the share of industry assets held by
community banks (organizations with less than $1 billion of assets) dropped
from 28 percent in 1984 to only 14 percent in 2003; and the smallest banks,
organizations with less than $100 million in assets, accounted as a group for
only 2 percent of industry assets in 2003—compared with 8 percent in 1984.
In terms of deposits, industry concentration has been
equally dramatic: a quarter of the nation’s domestic deposits are now
controlled by just 3 organizations (see table A.1), whereas in 1984 that same
proportion was held by 42 companies. At year-end 2003, Bank of America
Corporation, the largest holder of domestic bank deposits, held approximately
$512 billion in domestic deposits (9.8 percent of the industry) and had $870
billion in assets (9.6 percent of the industry).12 Also at year-end
2003, the 3,683 banking organizations that each held less than $100 million in
assets accounted as a group for only $192 billion of industry assets (2
percent, as noted above) and $160 billion (3 percent) of domestic deposits.
Analyzing banking industry concentration, Moore and
Siems (1998) and Rhoades (2000) found that, despite some recent increases,
national and local measures of concentration had remained, on average,
relatively low.13 This was surprising, given that many mergers had
been of the within-market type—those most likely to result in increases in
concentration. Hence, despite the heightened merger activity among banks over
the two decades 1984–2003, it appears that current concentration measures
generally remain below the level where monopolistic behavior might manifest
itself. Part of the reason may be that deregulatory efforts to lower entry
barriers and expand bank powers—helped along by advances in technology—have
resulted in an expanded geographic reach of competitors. Competition from
nonbank financial market participants also provides an important check on
market power. However, Rhoades (2000) does caution that, although MSA
(metropolitan statistical area) market concentration remains fairly low on
average, it has nonetheless increased substantially since 1984, and the
increase suggests that in the future there is likely to be a growing number of
MSA markets in which bank merger proposals raise significant competitive
Causes of Consolidation
Naturally policy makers, academics, and others have
wanted to know the “why” of consolidation. Why, after decades of seeming to
change so little, did the industry begin to consolidate and restructure itself
so dramatically? There is no single reason for the consolidation trend and no
single underlying cause. Rather, the trend might best be viewed as the result
of a combination of macro- and microeconomic factors: external forces that
fundamentally and irrevocably changed the environment in which banks operated,
and banks’ strategic responses to those environmental forces (ostensibly with
the goal of maximizing shareholder value). Previous studies of the
consolidation phenomenon have examined and discussed the various factors at
considerable length. Berger, Kashyap, and Scalise (1995), Berger, Demsetz, and
Strahan (1999), and Shull and Hanweck (2001), in particular, offer broad
reviews of the literature.14
At the macroeconomic level, consolidation has been
driven by exogenous changes in the banking industry’s economic environment, and
these changes have often worked in concert to encourage consolidation.
Foremost among them have been globalization of the marketplace, technological
change, deregulation, and major macroeconomic events (such as the thrift and
banking crises of the 1980s and the early 1990s, and the economic and stock
market boom of the late 1990s). Globalization and technological change have
been persistent forces for change over the entire period, and deregulation (in
its various manifestations) has been a recurring enabling force. In contrast,
the strength and influence of major macroeconomic events have varied over
time. For example, the economic forces that led to the thrift and banking
crises were influential primarily in the middle to late 1980s and early 1990s;
by the mid-1990s the crises were over, and bank and thrift failures were no
longer a major contributor to industry consolidation. Similarly, the influence
of the economic growth and stock market boom of the late 1990s was largely
restricted to a specific period. Hence, adding a temporal dimension to the
discussion of the external influences on consolidation will help us not only
understand the current trend but also formulate expectations about the future.
Globalization and Technology.
Globalization began slowly in the aftermath of World War II. After that war,
the major economies of the world gradually became more connected and
interdependent, This trend toward globalization accelerated in the 1970s and
1980s—in tandem with the beginnings of what would become a revolution in information
and telecommunication (ITC) technologies. Indeed, by the end of the twentieth
century, technological change would affect nearly every aspect of the business
of banking: the demand for banking services, the character and intensity of
sector competition, and the very structure of the industry.15 Through
what has been described as “a protracted series of technology shocks with
order-of-magnitude effects on the costs of transmitting and processing
information,” advances in ITC technologies have created new advantages of scale
in production and have lowered barriers to entry.16
Dramatically lowered costs and the ability to transmit
information almost instantaneously around the globe effectively freed the
financial services industry from the constraints of time and place. In the new
global financial economy, banks, securities firms, corporations, and even
individual investors became able to transfer huge amounts of capital around the
globe with the click of a mouse. Yet, while these new technologies enabled
financial firms of all types to exploit innovations in financial and economic
theory, engineer new products, and implement new techniques for managing risk,
they also resulted in a sharply more competitive marketplace for banking and
financial services. To survive and prosper, banking organizations needed to
respond to this new environment. Consolidation was one response. However, the
strict regulatory environment that existed before the 1980s largely precluded
any dramatic consolidation within the banking industry. Not until regulatory
constraints were relaxed did consolidation of the banking industry begin in
In the early 1980s, policy makers began a decades-long process of deregulating
the banking and thrift industries so that they could be more responsive to
marketplace realities (see table A.2). Over time, these legislative and other
deregulatory efforts gradually (albeit haltingly) loosened the constraints on
the industry, thus freeing it to cope more effectively with both the new
environmental challenges and the heightened competition that resulted. In two
areas—banking activities and branching—legislative and regulatory efforts were
particularly important for the consolidation trend: restrictions on permissible
banking activities were relaxed, and geographic limitations on branching were
removed. The importance of these two efforts is perhaps best illustrated by
the spate of interstate mergers that occurred immediately after passage of the
Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (figure
8). Although some researchers have argued that much of the merger activity
associated with the deregulatory process reflected only pent-up demand that had
been long accumulating because of other causal factors, there can be no doubt
about the influence of deregulation on the merger wave as it unfolded in the
United States: if deregulation in and of itself was not a primary causal
factor, it was certainly an essential enabling factor.17
In the 1970s—even before deregulation and before the full effects of the
revolution in ITC technologies had been felt—a series of macroeconomic shocks
combined with the twin forces of globalization and technology to dramatically
alter the economic environment within which banks operated. Indeed, the decade
of the 1970s saw the introduction of floating exchange rates, increased
volatility in interest rates, oil price shocks, stagflation, and unexpected
changes in other real economic and financial variables. These economic
conditions, and governmental responses to them, began putting stress on the
environment in which banks and thrifts had successfully operated, unchanged,
for many decades.
In the early 1980s these stresses were intensified by
double-digit inflation and then by the anti-inflationary monetary policies
designed to combat it. By mid-decade, wild swings in interest rates, combined
with sharp declines in oil and gas prices and in the value of real estate,
precipitated a series of rolling regional recessions that wreaked havoc on the
nation’s S&L and banking industries. The number of failures soared, soon
reaching (and then far exceeding) levels that had not been seen since the Great
Depression. But as bank failures rose to record levels, so did bank mergers
and acquisitions: federal regulators responded to the growing number of weak
and failing depository institutions and shrinking insurance-fund balances by
loosening their restrictions on mergers. The FDIC even provided financial
support to encourage better-capitalized and profitable banking organizations to
acquire weakened or insolvent institutions. As a result, during the 1980s the
consolidation movement was particularly strong.
* * *
The consolidation of the banking industry continued
into, and then through, the 1990s, but it is important to note that the forces
driving the trend in the 1990s differed markedly from the forces driving it in
the 1980s. Indeed, in many respects the 1980s and the 1990s were the worst of
times and the best of times (respectively) for the banking industry. Banks in
the 1980s were struggling under harshly unfavorable economic conditions and
outdated legislative and regulatory constraints. Many banks and S&L were
unprofitable. Many failed. In contrast, the middle to late 1990s saw a
convergence of several factors that created an environment extremely conducive
to merger activity. First, unlike the 1980s, the middle to late 1990s were a
period when banks were highly profitable, flush with cash, and reveling in
favorable economic and interest-rate environments. In fact, bank performance
from 1993 through the end of the decade (and beyond) would set multiple records
for profitability (figures 9 and 10). Second, Riegle-Neal’s removal of barriers
to interstate banking and branching provided opportunities for many
organizations to consolidate operations and pursue geographic diversification
through acquisitions. Third, a record-breaking bull market in stocks pushed
market valuations of banks and thrifts to unprecedented levels, encouraging
many banking firms to use their stock as currency to purchase the hard assets
of other banking firms (figure 11). This was especially the case when managers
believed their firms’ own stocks were “favorably” priced. Conversely, managers
of firms wishing to be acquired were able to maximize firm value by selling out
at record market-to-book valuations. While these conditions persisted,
consolidation continued at a relatively rapid pace—although it was partially
offset by a rise in the number of new bank start-ups.
At the end of the decade, however, several events
appeared to have had a markedly dampening effect on bank merger activity and on
the pace of industry consolidation. First, Y2K-related concerns might have
caused some merger plans to be postponed until after the beginning of the new
millennium. Then in March 2000 the record run-up in stock prices reversed
itself.18 A year later (in March 2001) the U.S. economy entered a
mild recession. Coincident with these adverse economic developments, a
significant accounting change in the way mergers were recorded served to
discourage stock-funded bank merger transactions.19 Finally, the
terrorist attacks on the World Trade Center and the Pentagon on September 11,
2001, and the subsequent wars in Afghanistan and Iraq adversely affected the
broader economic and business environments. Nevertheless, consolidation in the
banking industry continued into the twenty-first century, though at a much
As we have just seen, at the macroeconomic level
consolidation has been influenced by technology, deregulation, macroeconomic
events, and other environmental factors. But it is the microeconomic factors
that, in the aggregate, are largely responsible for the consolidation trend.
These factors are the individual decisions by banking firms to pursue a merger
or acquisition strategy. From a microeconomic perspective, a bank’s decision
to consolidate charters—to merge with or acquire another firm—should reflect
management’s chosen strategy for maximizing or preserving firm value in the
face of increased competitive pressure stemming from a more market-oriented
environment. For example, a merger strategy can be based on value-maximizing
motives, such as achieving economies of scale and scope or reducing risk or
increasing profits through geographic and product diversification. Indeed, in
a recent survey of bank management, value-maximizing motives were most often
cited as the principal reason to undertake a merger.20
A firm’s decision to merge, however, may also be
influenced by motives that do not necessarily maximize the firm’s value.
Adverse changes in a bank’s competitive environment may compel a banking firm
to undertake an acquisition as part of a purely defensive strategy, or merger
decisions may be based wholly or partly on the self-serving motives of
managers. (Bliss and Rosen  and Ryan , for example, suggest that
empire building and increased managerial compensation might be the primary
motive behind some bank mergers.) Another motive—suggested by Shull and
Hanweck (2001), Penas and Unal (2004), and others—is a desire to obtain
“too-big-to-fail” status and the funding and other competitive advantages that
seem to accrue to the largest and most complex banking organizations.
Just as economic and
regulatory conditions in the 1980s differed significantly from those in the
1990s, some economists have suggested that the motivations behind bank mergers
in the 1980s were different from the motivations behind the mergers of the
1990s. Berger (1998, 106) observes that
with a change in merger motives, many of the merger participants in the 1980s
focused on expanding their geographic bases to gain strategic long-run
advantage by getting footholds in new locations, rather than on reducing costs
or raising profits in the short run. Merger participants in the 1990s appear
to be more focused on cutting costs quickly through mergers—for example, they
often announce goals for employee layoffs, branch closings, and total cost
savings in advance of mergers.
It may well be that merger motives have changed over
time. Additional research will undoubtedly help us better understand if this
Effects of Consolidation
Perhaps more important than knowing why consolidation
has occurred in the U.S. banking industry is understanding what its effects
have been on the banking industry, its shareholders, and the customers served.
In theory, globalization, technology, and deregulation should have resulted in
a significant increase in competition. Increased competition, in turn, should
drive value-maximizing managers to seek greater efficiencies through
consolidation. In other words, if profit-oriented managers think that there
are economies of scale or scope to be gained or that opportunities exist to
replace inefficient managers at other firms or to enhance profitability by
servicing customers better, a competitive environment will encourage these
managers to seek such economies or opportunities. Of course, the question of
whether the current consolidation trend has made the banking industry more
efficient or a better provider of services to the banking public is an
Fortunately, the effects of consolidation have been a
particularly active area of empirical research for more than a decade, and a
consensus is beginning to form. Table A.3 gives a synopsis of these general
findings. However, we should first note that researchers have faced substantial
econometric difficulties in their attempts to test for efficiency and other
potential gains from consolidation. Pilloff and Santomero (1998) and Calomiris
and Karceski (1998), in particular, have enumerated several methodological
pitfalls that make it hard to assess the effects of consolidation accurately.
Among the pitfalls are these: (1) because of increased competition, efficiency
gains from mergers might not be reflected in net earnings; (2) lags in
performance improvement may be extensive (three to five years), especially for
mergers motivated by strategic goals such as diversification rather than by a
desire to cut costs; (3) constructing a believable benchmark (for purposes of
comparison) in the midst of a merger wave may be difficult; and (4) controlling
for multiple causal and motivational factors over time and across mergers may
be difficult. In addition to these methodological difficulties, there is also
likely to be a problem reconciling the findings of studies based on 1980s data
with the findings of studies that use 1990s data. Furthermore, as our
chronological account indicates, the causal factors (and probably the
motivations) driving mergers in the 1990s were very different from those
driving mergers in the 1980s. With these qualifications in mind, we now
briefly summarize the existing evidence about the effects of consolidation.
On the positive side, findings to date suggest that
consolidation has resulted in somewhat greater profit efficiency (profit
efficiency measures how close a bank is to earning the maximum profits that a
best-practice bank would earn under the same circumstances).21
According to Berger (1998), profit efficiency is enhanced by mergers because
the combined firms generally achieve greater diversification of their risk
exposures through a better mix of geographic areas, industries, loan types, and
maturity structures. In turn, improved diversification might allow the
combined banking organization to undertake a portfolio shift from security
investments into consumer and business loans—activities with higher expected
values. Hence, profit efficiency would be greater with consolidation because
capital is put to better use and because greater geographic diversification
tends to reduce risk.22
Findings to date also suggest somewhat greater
payment-system efficiency (see Hancock, Humphrey, and Wilcox  and Adams,
Bauer, and Sickles ) and, for institutions that have increased their
geographic diversification, possibly a lower risk of insolvency (Group of Ten
 and Berger and DeYoung ). Finally, a potential negative effect of
the reduced number of banking organizations has been avoided: access to banking
services (including lending to small businesses) seems to have been relatively
unaffected (see, for example, Avery et al. , DeYoung et al. , and
Jayaratne and Wolken ).
On the other hand, most
researchers—especially those focusing on the 1980s and early 1990s—have not
been able to identify any of the broad-based improvements in cost efficiency
that one might have expected from economies of scale or scope.23
Given that managers most often cite gains from increased cost efficiency as the
primary motivation for strategic consolidations, this finding (or the lack
thereof) represents a fairly substantial puzzle. Some researchers have tried
to explain away the lack of support for economies of scale by citing
measurement and econometric difficulties and a time horizon too short for
making observations. And in fact, a few more-recent studies that claim to have
overcome some of these obstacles have reported results suggesting that
scale-related efficiency gains in the 1990s have been substantial (Hughes,
Mester, and Moon  and Hughes, Mester, and Moon , among others).
Additional investigations into gains in efficiency will undoubtedly help solve
In addition to lacking consensus on cost-efficiency
gains, empirical work to date has also failed to find substantive evidence of
other benefits that one might hope consolidation would yield. For example,
there is little evidence that either consumers or shareholders have benefited
from consolidation in the industry (Shull and Hanweck , Kahn, Pennachi,
and Sopranzetti , and Prager and Hannan ). Rather, there is growing
evidence that increases in market power at the local level may be adversely
affecting consumer prices (for both depositors and borrowers).24
And as we mention above, there is also some evidence that managers may be
pursuing mergers and acquisitions for reasons other than maximizing firm value:
researchers who have studied the issue have consistently found support for the
idea that empire building and increased managerial compensation are often
primary motives behind bank mergers.25 Finally, findings from
several researchers suggest that industry consolidation and the emergence of
large, complex banking organizations have probably increased systemic risk in
the banking system and exacerbated the too-big-to-fail problem in banking.26
Thus, despite the many empirical studies of
consolidation in the U.S. banking industry, much uncertainty remains not only
about the importance of the various factors behind the merger trend but also
about the effects of consolidation on bank shareholders and on those who use
banking services. Before we can fully understand either the causes of
consolidation or all its ramifications, more work needs to be done.
of Banking Industry Structure
Because banks play an important role in the U.S.
financial system, changes in the industry’s structure are likely to have
widespread effects. Hence, for planning purposes it would be useful if
structural changes could be anticipated before they occurred.
Review of Previous Projections and
Of the studies that have documented and discussed the
decline in the number of banks, several—including Hannan and Rhoades (1992),
Nolle (1995), Berger, Kashyap, and Scalise (1995), and Robertson (2001)—have
also projected the future size and structure of the banking industry. Most of
these projections are based on linear extrapolations from past trends.
Although these studies all use somewhat different approaches, they all
predicted a sharp decline in the number of commercial banking organizations
through the decade of the 1990s and beyond.27
In the earliest of these papers, Hannan and Rhoades
(1992) approached the task of projecting future U.S. commercial banking
structure by assuming that the national trend would follow past responses to
the relaxation of interstate banking regulations at the regional level.
Accordingly, the authors examined more closely the structural transition to
interstate branching experienced by the Southeast and New England over the
period 1980–1989.28 The authors approximated linear trends for each
region by calculating an average annual rate of change in the number of
commercial banking organizations for the period studied (and for the subperiod
1984–1989). They then assumed that the number of commercial banking
organizations in the nation starting in 1989 would change at the rate that had
been observed in the two regions. This method projected the number of
commercial banking organizations in the United States to be in the range of
5,000 to 6,000 by the year 2010 (depending on the region and period used). For
comparative purposes, the authors also based projections on extrapolations from
national trends. This resulted in a projection of just over 5,000 commercial
banking organizations by 2010.
In addition to extrapolating from regional and national
trends, the authors also extrapolated from the banking structure observed in
the state of California, where intrastate branching had been allowed since
1908. The commercial banking structure in California, they reasoned, would
represent a sort of equilibrium case since the structure there had evolved in
the absence of branching restrictions over a long period of time. In this
extrapolation, the authors assumed that once all geographic restrictions on
branching were lifted, the ratio of commercial banking organizations to bank
deposits nationwide would approach the ratio already observed in California.
Projections to 2010 based on this approach varied depending on the period used
to formulate the trend. However, according to the authors the most realistic
projection indicated that the U.S. banking industry would eventually shrink to
about 3,500 commercial banking organizations.29
Given the range of predictions yielded by the different
cases, Hannan and Rhoades eventually offered a “best-guess” projection for the
year 2010 of 5,500 commercial banking organizations. Regardless of
methodology, however, all extrapolations suggested that, even with a
continuation of the decline, the long-run equilibrium banking structure in the
United States would probably consist of a very large number of banking
Nolle’s 1995 paper likewise attempted to simulate the
possible effects on the U.S. banking structure of liberalizing interstate
branching restrictions. Using data on the state-by-state pattern of mergers,
failures, and entries over the seven-year period 1987–1993, Nolle mechanically
projected the number of commercial banks (individually chartered institutions)
through the end of the year 2000. He considered two scenarios: an
extrapolation from past trends under the assumption that legislation allowing
nationwide interstate branching would not be enacted, and a judgmental
adjustment of the first scenario assuming that interstate branching legislation
would be passed in 1994 and fully enacted by midyear 1997 (this latter scenario
proved to be historically accurate).30 Results from the first
scenario (the no-interstate-branching case) indicated a decrease of just under
2,100 banks (to 8,798 institutions) during the period 1994–2000—a decrease
equal to about two-thirds of the amount of consolidation observed over the
1987–1993 period. The second extrapolation (the interstate-branching case)
suggested that the total additional effect on consolidation of interstate
branching would be an additional decline of about 1,000 banks (resulting in an
industry total of 7,787 commercial banks in the year 2000). Given these
results, Nolle concluded that interstate branching would not fundamentally
alter the structure of the nation’s commercial banking industry; that is, there
would still be thousands of commercial banks and thousands of bank holding
companies in existence at the turn of the millennium.
A conclusion similar to those reached by Rhoades and
Hannan (1992) and Nolle (1995) was reached by Berger, Kashyap, and Scalise
(BKS, 1995) as well, but they used a much more complex methodology. To
quantify the possible effects of the removal of all state and federal
restrictions on interstate branch banking, BKS constructed an econometric model
to explain the distribution of domestic commercial bank assets across
organization size classes on a state-by-state basis. In their model, the
proportion of banking assets in each size class was assumed to be a function of
state demographic variables as well as of a number of independent variables
that had been designed to capture differences in the existence and the lifting
of regulatory restrictions on statewide and interstate branching as well as on
multibank holding company acquisitions.
Using the regressions, BKS then simulated the effects of
nationwide interstate banking for 5 years, 10 years, 25 years, and the long
term, under two scenarios: first, assuming zero growth of gross domestic
banking assets; second, assuming asset growth at the national trend rate over
the sample period (1979–1994). For each scenario the authors assumed that
nationwide banking occurred immediately (in 1994); they therefore removed all
variation among the explanatory variables related to the liberalization of
geographic restrictions, except for variables capturing
time-since-liberalization effects. These time-effect variables were adjusted
for the number of years to be projected in the simulation. The changes in the
predicted proportions for each size class for each state were then added to the
actual proportions in 1994 to obtain the future value. The predicted shares of
domestic banking assets for each size class were then aggregated across the 50
states to obtain a weighted average proportion of assets in each size class at
the national level. Finally, BKS obtained an estimate of the number of
commercial banking organizations in each size class by dividing the projected
total dollar value of assets in each size class by the average size of
organizations in that size class in 1994.
Results from the zero-growth simulations indicated that
“the removal of all geographic barriers to nationwide banking was likely to
result in continued substantial consolidation of the banking industry.”31
Specifically, in this scenario the model predicted that the number of
commercial banking organizations would fall by almost 4,000 by 1999, from a
total of 7,926 to 4,106—a decline of almost 50 percent over five years.
Surprisingly, little change was predicted to occur after 1999. When gross
domestic assets were allowed to grow at trend rates, the predicted increase in
consolidation in the first five years due to enactment of interstate branching
was even greater: the number of commercial banking organizations falls to
3,440. In contrast to the zero-growth simulation—which predicted little
consolidation after the first five years—the growth simulation projected the
number of organizations as continuing to fall. Under this scenario the number
of banking organizations falls to 1,939 in 25 years—a decline of 76 percent
from 1994 levels. Notwithstanding these reductions, BKS’s simulations still
predicted that the banking structure in the United States would be
characterized by thousands of small banking organizations. This finding was
consistent with the findings of Hannan and Rhoades (1992) and Nolle (1995).
Finally, Robertson (2001)
projected the number of commercial banking organizations in each size class by
first calculating a transition matrix that indicated the probability that a
bank would remain in the same size class from one year to the next, move to a
new size class, or leave the industry altogether. After confirming matrix
stability, he then applied the transition probabilities from the 1994–2000
transition matrix to the year-end 2000 numbers to obtain estimates for the
industry’s future size distribution. On the basis of this methodology,
Robertson predicted that the number of commercial banking organizations would
continue to decline—from 6,750 in 2000 to 4,567 in 2007, for a 32 percent
reduction. Like the projections of earlier studies, Robertson’s suggested that
the number of smaller banking organizations would continue to fall steadily.
Indeed, Robertson’s simulation predicted that the number of banking
organizations with less than $100 million in real assets would decline by
nearly 40 percent over the seven-year period he was forecasting.
New Linear Extrapolations: A Comparison with the Literature
On the basis of earlier
studies, then, it seems that we can expect to see further declines in the
number of banking organizations, especially in the community banking sector
(where the number of organizations with less than $100 million in assets is
expected to continue to fall dramatically). Some of the aforementioned
projections, however, are based on data that are more than a decade old. We
show above that the decline in the number of banking organizations, while
ongoing, has slowed appreciably in the last few years. This slowing should
have important implications for expectations about the future structure of the
banking industry. Consequently, we have formulated new projections of industry
structure based on the latest observed trends.
a starting point, we adhered to the linear approach to project the number of
banking organizations in each of five size classes through the year 2013. Our
projections are based on the average quarterly net change over the five-year
period 1999–2003. We chose to focus on only the last five years of data
because we believe that the change occurring over this period better reflects
the mix of forces affecting the banking industry at the turn of the millennium
and that this period is therefore most relevant to anticipating the future
direction of the industry’s structure. To make our projections comparable with
those of earlier studies, we projected both the number of commercial bank
organizations and the number of commercial bank and thrift organizations
combined. Table 1 presents our five- and ten-year projections. As can be seen
in panel A, our linear extrapolations suggest a continuing decline (of 34
organizations per quarter) in the total number of banking and thrift
organizations—from 7,842 at year-end 2003 to 7,161 at year-end 2008 and to
6,480 at the end of 2013. The projected decline over five years is 681
organizations (8.7 percent); over ten years, twice that. Projections for
commercial bank organizations alone (panel B) show a similar pattern.
Interestingly, projections for both groups indicate that the decline will occur
exclusively within the smallest size group (organizations with less than $100
million in assets). Our extrapolations from the trends of the past five years
indicate that all other size groups will grow by small amounts.
Table 1 - Projected Number of Banking Organizations, 2003-2013
For comparison, figure 12
contrasts our linear projections for the number of commercial bank
organizations with those from earlier studies. Remarkably, Hannan and
Rhoades’s (1992) “best-guess” 20-year projection for the number of commercial
bank organizations in 2010 is not that much different from our own—their 5,500
compared with our 5,847. The projections by BKS (1995) and Robertson (2001),
however, suggest significantly more of a decline among commercial bank
organizations than is indicated by our linear extrapolation from the data for
the last five years.
Beyond Linear Extrapolations
Although linear extrapolations like those described
above provide a simple means of projecting industry structure, Shull and
Hanweck (2001) have argued that projections based on simple linear
extrapolations of past trends are inadequate because they fail to specify the
process generating the structural change. We tend to agree. Although we used
the linear approach for illustrative purposes, we believe this approach is
somewhat naive because it fails to incorporate all the information contained in
the data. Most importantly, it ignores the changing nature of the forces
behind the decline in the number of organizations. Consequently, for reasons
that will soon become clear, we view our linear projections as representing the
lower bound of our estimates of the future size of the banking industry.
To improve on the simple linear extrapolations presented
above, what is needed is a forecasting methodology that can capture the
underlying features of the full time series on banking structure. An extremely
general econometric model that promises to do this in a simple and expeditious
manner is the autoregressive integrated moving average time-series model
(ARIMA). First developed by Box and Jenkins (1976), this approach to modeling
the processes that generate a time series of data has “withstood the test of
time and experimentation as a reasonable approach for describing underlying
processes that are probably, in truth, impenetrably complex.”32 In
simple descriptive terms, this class of models either regresses a time series
on its own past values or uses a moving average process to express a times
series as a linear combination of past error terms, or does both. In practice,
the Box-Jenkins approach to time-series model building has been made relatively
easy through the use of modern statistical software programs. After testing
various models for fit, we selected for our forecasting a first-order moving
average model, fit to the second-differenced log of the time series.33
Figure 13 illustrates our forecasts of the total number
of banking organizations for the years 2004–2013, based on the estimated
parameters of our time-series model. As can be seen, we project the
consolidation trend in the banking industry as continuing over the next ten
years, albeit at a slightly slower pace over the second five-year period. In
the near term (the next five years), according to our model, the industry will
decline by a total of 552 organizations, from 7,842 at year-end 2003 to 7,290
by the end of 2008 (a decline of 7 percent). By 2013, our forecast shows the
banking industry shrinking by an additional 424 organizations, to 6,866 (a 6
percent decline)—for a total reduction of almost a thousand organizations (or
slightly more than 12 percent) over the ten-year period.
Although we believe that
the forecast based on our moving average model is a substantive improvement
over the forecast obtained through the simple linear extrapolation method,
another interpretation of the data suggests that consolidation of the industry
is slowing more appreciably than is suggested even by our time-series
forecast. Indeed, according to an interpretation presented by Shull and
Hanweck (2001), the decades-long consolidation trend in banking may come to an
end in the not-too-distant future. Basically, Shull and Hanweck view the
structural change in banking as a dynamic and nonlinear process in which a
population of banks in a stable state has been subjected to an exogenous shock
(or shocks) that causes the population to shift to a new steady-state
equilibrium. According to this interpretation, the reduction in the number of
banking organizations is characterized as a situation in which an equilibrium
banking structure (described by the stability in the number of banking
organizations in the United States before 1980) was disturbed by economic,
regulatory, and technological changes. The consequent decline reflected a
transitional movement toward a new equilibrium structure.
Figure 14 follows Shull
and Hanweck in using a phase diagram. It plots the quarterly rate of change in
the number of banking organizations against the actual number of organizations
for the period 1984–2003. In the diagram we can observe a distinct
transitional pattern (as indicated by the trend line) from an equilibrium
structure of just over 15,000 organizations (when the rate of change was last
near zero) to the current structure of just under 8,000 organizations (at
year-end 2003). Indeed, the transitional nature of the plot is quite
dramatic. One noteworthy feature of the diagram is that once the numbers of
banking organizations began to decline, they did so first at an increasing rate
and then at a decreasing rate. The turning point appears to have been at about
11,500 organizations. This is roughly the size of the industry in mid-1992.
Interestingly, that year marked both the end of a national recession and the
unofficial end of the S&L and banking crises. And if we layer the phase
diagram with a time line, it becomes easy to see how the transition has
progressed since 1984.
Extension of the trend
line to a point of intersection with the zero-rate-of-change line would
indicate that the structure of the banking industry will again reach an
equilibrium structure in about five years, at approximately 7,250 organizations
(assuming that progression along the trend proceeds unimpeded). The conclusion
to be drawn from the phase diagram—that the decline in the number of banking
organizations has slowed appreciably and that industry structure is likely to
stabilize within the next few years at about 7,250 organizations—is at least
numerically consistent with the five-year forecast generated by our moving
Considered together, our three forecasts (based on
linear extrapolation, time-series modeling, and a phase diagram) imply that in
the absence of a new shock to the industry, the U.S. banking industry is likely
to retain a structure characterized by several thousand very small to
medium-size community bank organizations, a less-numerous group of midsize
regional organizations, and a handful of extremely large multinational banking
organizations. Consistent with projections from earlier studies, our
projections indicate that the U.S. banking industry is not likely to resemble
the banking industries in countries such as Germany, which have only a handful
of universal banks.
Although our forecasts contrast rather sharply with
conventional wisdom about the future pace of decline in the number of banking
institutions, we believe these projections to be reasonable under current
conditions. The major influences of the 1980s, under which the decline
accelerated, are no longer relevant. Gone are the high failure rates and other
contractionary influences of the thrift and banking crises. Similarly, the
effects of the liberalization of interstate banking and branching laws are
largely in the past, as are the effects of most other major deregulatory
initiatives. Bank holding companies, for example, have already collapsed
inefficient multistate, multibank structures, and opportunities for additional
gains are limited. This might be especially true for the larger banks (which
have been particularly active merger participants) as they become increasingly
constrained by state and federal limits on deposit market shares. Also gone
are the merger-accommodating atmosphere and the “irrational exuberance” that
accompanied the amazing stock market boom of the late 1990s.
In their place is a more uncertain economic environment
that has spawned fewer bank mergers and consolidations. Although we believe
that sustained industry profitability and competitive pressures will lead to
some additional decline in the number of banking organizations going forward,
we do not foresee a return to the rate of decline witnessed in the late 1980s
and early 1990s. Rather, we see a balance developing between the number of
bank start-ups and the number of charter losses due to mergers and
acquisitions—with little net change in the number of banking organizations
nationwide. In other words, it just might be that the consolidation trend in
banking—that “long, strange trip”—is nearing an end.
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Table A1 - Share of Industry Assets and Deposits Held by the Nations's 25 Largest Banking Companies (Pro-forma) data as of December 31, 2003
Table A2 - Major Legislative and Regulatory Changes Affecting Banking Consolidation
Table A3 - Summary of Recent Empirical Studies and the Causes of Consolidation in the Banking Industry
* The authors are in the Division of Insurance and Research at the
Federal Deposit Insurance Corporation. Kenneth D. Jones is a senior financial
economist, and Tim Critchfield is a senior financial analyst. The authors wish
to thank Tyler Davis, Ron Kidd, Terry Kissinger, Steve McGinnis, and Chau
Nguyen for their valuable assistance. The views expressed in this paper are
those of authors and not necessarily those of the FDIC. Naturally, any errors
are the responsibility of the authors.
2In 2004, the FDIC released its findings from a comprehensive
research project looking into the future of banking. The study as a whole
projects likely trends in the structure and performance of the banking industry
and anticipates the policy issues that will confront the industry and the
regulatory community in the coming years. Copies of the research papers making
up the study can be obtained at http://www.fdic.gov/bank/analytical/future/index.html.
3Discussions about the declining number of banks can be found not
only in the paper already mentioned (Berger, Kashyap, and Scalise ) but
also in Berger, Demsetz, and Strahan (1999); Hughes, Lang, Mester, and Moon
(1999); and the Group of Ten (2001).
4Data limitations at the level of banking organizations restrict
our analysis to the years 1984–2003. And because the number of commercial
banks alone peaked in 1984 at 14,496, we use that year as the beginning of our
discussion of the consolidation trend, even though in certain respects the
transformation of the U.S. banking industry may be said to have begun earlier.
5The expansion of banking powers over the period we are studying
has left few differences between commercial banks and savings institutions
(thrifts), so unless otherwise specified, our analysis combines the two types
of institutions. Moreover, we focus on top-tier organizations rather than on
individual institutions in order to avoid counting multiple charters belonging
to a single corporate entity. The count here for year-end 1984 (15,084)
includes all active organizations, whereas figure 1 (which shows a total of
14,884 organizations for year-end 1984) includes only organizations that filed
a financial report at the end of 1984.
6Asset size classes have been adjusted for inflation using the GDP
price deflator with 2002 as the base year. Hence, the number of banks in 2003
that had less than $100 million in assets is comparable to the number of banks
in 1984 that had less than $66 million in assets.
7“Other additions” included in figure 4 were non-FDIC-insured
institutions that became FDIC-insured, often transferring from state insurance
programs in the mid-1980s. “Other changes” were voluntary liquidations of
8The sole exception was 1989, when the savings and loan (S&L) and
banking crises were near their peak.
9This number includes not only 2,262 organizations (including
multibank holding companies) that were eliminated because of failure but also
individual charters that were merged into other charters with FDIC assistance;
however, it does not include insolvent institutions that remained open with
FDIC financial assistance.
10The number of failures peaked in 1989, when 536 banks and thrift
11We determined real growth by adjusting nominal dollars for
inflation using the GDP chain-type price deflator, with 2002 selected as the
12In October 2003, Bank of America announced that it would acquire
the nation’s eighth-largest bank—FleetBoston Financial—in a $47 billion
all-stock transaction. Our numbers are for the combined organization based on
year-end 2003 data.
13Standard measures of concentration include the
Herfindahl-Hirschmann Index (HHI—defined as the sum of the squares of the
individual market shares of all banks in the market) and the three-firm
concentration ratio (CR3—that is, the percentage of deposits accounted for by
the three largest banking organizations in the market).
14Expanded discussions of the macroeconomic forces driving
consolidation can also be found in Rhoades (2000); Hannan and Rhoades (1992);
and Boyd and Graham (1998). The microeconomic underpinnings of banking
consolidation are discussed in Hughes, Lang, Mester, Moon, and Pagano (2003),
Milbourn, Boot, and Thakor (1999), Calomiris and Karceski (1998), and Hughes,
Lang, Mester, and Moon (1996).
15For more detailed discussions of technology and the effects it has
had on the restructuring of the financial services sector, see Berger (2003),
Berger and DeYoung (2002), the Group of Ten (2001), Hunter (2001), Mishkin and
Strahan (1999), and Emmons and Greenbaum (1998).
17As mentioned, the Riegle-Neal Act (along with regional interstate
compacts that repealed interstate branching restrictions) had a significant
effect on bank merger activity and industry consolidation. In contrast, the
latest legislative initiative aimed at modernizing the financial services
industry—the Gramm-Leach-Bliley Act of 1999 (GLB)—has not had a similar
effect. As explained by Rhoades (2000), GLB provides for cross-industry
mergers between banks, securities firms, and insurance companies. However,
such combinations are likely to be considered by only the largest banking
organizations. Moreover, by definition, the combination of a banking firm and
another type of financial services provider does not result in the loss of a
bank charter. Hence, the combination will have no effect on the number of
18For the next several years, all the major stock indexes would fall
dramatically; from March 2000 to March 2003, for example, the S&P 500
benchmark fell a cumulative 43 percent.
19Financial Accounting Standards Rule 141 (FAS 141) terminated the
use of pooling-of-interest accounting for business combinations after 2001 and
required that purchase accounting methodology be used instead. Purchase
accounting requires a firm to record goodwill if the market value of net assets
acquired is less than the purchase price. Historically goodwill was amortized
regularly, but now (under FAS 142) companies must test goodwill (and other
intangibles) for impairment once each fiscal year. A finding of impairment may
require additional noninterest-expense recognition.
21Berger’s (1998), concept of profit efficiency includes not only
the cost-efficiency effects of mergers and acquisitions but also the revenue
effects of changes in output that occur after a merger.
22For additional evidence on increased profit efficiencies, see
Akhavein, Berger, and Humphrey (1997) and Boyd and Graham (1998).
23A number of studies have found little or no evidence of scale
economies. These include Stiroh (2000) and Berger, Demsetz, and Strahan
(1999). Additional studies with similar findings are listed in table A.3. For
the findings on scope economies, see Stiroh (2004), Amel et al. (2002), DeLong
(2001), and Demsetz and Strahan (1997), among others.
24See Shull and Hanweck (2001), and Berger, Demsetz, and Strahan
(1999), among others.
25See, for example, Hughes, Lang, Mester, Moon, and Pagano (2003),
Bliss and Rosen (2001), and Gorton and Rosen (1995).
26Support for the too-big-to-fail motive is found in Shull and
Hanweck (2001), Penas and Unal (2004), and Kane (2000). Studies on systemic
risk include De Nicola and Kwast (2002) and Saunders and Wilson (1999).
27To the best of our knowledge, all previous studies excluded thrift
organizations and projected only the numbers of commercial banking
organizations or institutions.
28Nolle (1995) reports that by 1984, most of the six New England
states had established reciprocal arrangements allowing bank holding companies
to own (typically through acquisition) banking subsidiaries in another New
England state; by 1987, all six states were participating in these
arrangements. Similarly, by 1985 most of the states in the southeastern region
of the country had accepted reciprocal arrangements, and by 1988 all of them
29Extrapolations from the 1980–1989 period actually predicted a
slight increase in the number of commercial banking organizations nationwide.
The estimate of 3,500 organizations is based on the trend from 1984 to 1989.
30For his interstate branching scenario, Nolle assumed that no
states would choose to opt out of interstate banking or branching provisions;
that all multistate, multibank holding companies (MSMBHCs) in existence at
midyear 1993 would still be in existence at midyear 1997, when interstate
branching was assumed to be fully in effect; and that as a group these MSMBHCs
would “branch up” 75 percent of their out-of-home-state subsidiary banks by
33Given a time series, one can estimate several types of models
within the class of ARIMA models. Model selection can then be based on the use
of information criteria such as Akaike’s information criterion (AIC) or
Schwarz’s Bayesian criterion (SBC), which seek to identify the “best”
model—best in terms of accuracy and efficiency. We chose to use the SBC
because of its greater emphasis on parsimony. Among the models tested, we
settled on a first-order moving average model where the model was fit to the
second-differenced log of the time series using maximum likelihood estimation
(ARIMA [0,2,1]). Second-differencing was needed to achieve stationarity—an
important underlying assumption of model estimation. To confirm stationarity,
we examined the autocorrelation and partial correlation functions and conducted
a Dickey-Fuller unit root test. See Box, Jenkins, and Reinsel (2000) or Judge
et al. (1988) for a more detailed explanation of time-series model estimation
and fit. Further details on model selection and testing are available from the
authors of the present study.