The Origins And Perils Of Bank Consolidation

One of the interesting things about journalism is the way tone makes all the difference. I could write that in contrast to the smartphone sector where four operating systems control over 95 percent of the market, the American banking sector is incredibly diffuse. Ten institutions control 54 percent of deposits and the other 46 percent are divided up amidst a staggering 8,000 players. There are a few other markets like that, mostly composed of businesses where there are few economies of scale (restaurants) or else a lot of local regulatory variance (liquor stores), but banking is a bit weirdly diffuse.

And yet here’s Mother Jones on the same facts. Some major mergers and acquisitions over the past 20 years:

The nation’s 10 largest financial institutions hold 54 percent of our total financial assets; in 1990, they held 20 percent. In the meantime, the number of banks has dropped from more than 12,500 to about 8,000.

The solution to the riddle is that until the Riegel-Neal deregulation of 1994 banks actually were regulated like liquor stores. And having knocked public choice economics recently, I wound up coming across a really interesting public choice paper on the transition by Randall Kroszner and Philip Strahan called “What Drives Deregulation? The Economics And Politics of the Relaxation of Bank Branching Restrictions” (PDF) that was published in 1999.

Kroszner and Strahan are public choice guys. They believe government regulations are motivated by private capture of the power of the state, not by efforts to promote the public interest. In their view, regulatory prohibitions on bank branching arose because state legislatures wanted to use their chartering power to raise revenue. Then they persisted because inefficient small banks wanted to block competition. This was bad for consumers, so it was good for the public interest when the restrictions were lifted. But there’s a mystery here. If public interest regulation can’t happen, then public interest deregulation shouldn’t happen either. They take advantage of the fact that state-level lifting of branch restrictions occurred unevenly over a span of time to argue that the strength of the small bank lobby, rather than concern for the public interest, was the driving factor here. They then offer a historical materialist account of why small banks began to lose market clout, focusing on the technological innovation of the ATM and the development of the money market fund. These innovations weakened small banks, leading to some relaxation of anti-competitive rules, then competition further weakened small banks leading to further relaxation of anti-competitive rules.

They conclude their story in the happy year 1999, with the industry seeing pro-competitive forms of consolidation and the consumer benefitting from policy change even though policymakers don’t care about the public interest. Having removed the barriers to mergers and competition with small banks, the bank lobby grew even stronger and more rapacious. The result was the development of a national growth strategy of finance-led industrial policy focused on light-tough bank supervision, capital inflows, trade deficits, and homebuilding. This strategy had important affinities with the converse strategy being implemented by the People’s Republic of China and eventually drove us off the cliff.

What’s more, the real lesson of the MoJo bank consolidation chart should be that there remains a ton of scope for further consolidation. Today’s big banks are very large, but 8,000 is still a ton of banks and the branching restriction rules were repealed relatively recently.