Recently, four Senate Democrats urged the Federal Reserve to take a stronger stance on blocking bank mergers after the prominent Silicon Valley Bank (SVB), Signature Bank and First Republic Bank failed and left other players to absorb assets.
The legislators are concerned that a permissive approach to mergers risks creating more “too-big-to-fail” banks — those with systemic importance to other economic sectors that necessitate bailouts when near collapse. Some politicians and the Department of Justice (DOJ) also argue that an increasingly concentrated banking sector leaves consumers with fewer choices.
These concerns have merits. However, they overemphasize the number of banks over whether a merger leaves customers better off and ignore the incentives driving mergers — including massive, costly growth in regulations, declining confidence in smaller banks and stifled competition.
Bank regulatory capital requirements alone account for one-quarter of the entire U.S. Code of Federal Regulations. The 2010 Dodd-Frank Act imposes more than $50 billion annually in regulatory compliance costs on U.S. banks, including consulting, legal, auditing and data processing. These costs may be passed to consumers through higher fees.
A significant motivation to merge is that bigger businesses can more easily afford the high fixed costs of regulation. Their scale economies make them more resilient to crises and more apt to bear investment risks. It’s also no surprise, then, that depositors responded to recent small-bank failures by shifting to larger institutions.
These are among the reasons why making it harder to secure merger approvals risks harming small banks. An adverse, uncertain regulatory climate has already chilled merger activity.
Focusing on the raw number of banks is also misguided. America has far more banks per capita than comparable economies like Canada and Australia. Fewer banks don’t necessarily mean less competition or consumer welfare. Rather, it could reflect how customers demand more services from banks than ever and fewer, more efficient entities with greater scale meet their needs. America’s 4,000+ banks also make supervising the system harder. The Federal Reserve recently admitted that it knew SVB was flouting regulations but acted sluggishly. Blocking more mergers could worsen this problem.
As for consumer choice, big banks may compete less vigorously to attract customers through lower account fees and favorable credit terms and instead prioritize wholesale funding sources that smaller banks can’t access, like foreign deposits and certain federal government programs. Conversely, though, bigger banks offer more services and extensive ATM and branch networks. That’s one reason a merger’s future impact on consumer welfare and choice isn’t always clear.
The branch closures that typically follow the merger of two big banks in areas where their operations overlap can depress local lending. However, it’s unclear if small bank mergers or mergers between small and big banks generally depress or enhance lending. Regardless, these effects can be avoided or minimized by requiring both parties to offload branches in overlapping areas to another bank before merger approval — a solution the current DOJ is skeptical about, instead favoring blocking more mergers outright.
What is clear is that mergers should be blocked only when based on strong quantitative evidence of likely consumer harm attested by a thorough analysis of the specific deal and market — not speculative theories or assumptions based solely on market share. Unfortunately, DOJ leadership has instead adopted the 1963 Philadelphia National Bank Supreme Court case as its lodestar for merger analysis, which classifies mergers creating a 30 percent share of the relevant geographic or product market as presumptively illegal.
Economists and courts have since largely abandoned this approach. Overemphasizing market share can show false positives of anticompetitive effects, imperiling mergers that could help customers. It doesn’t consider whether it’s plausible for the merged entity to raise prices or restrict customer services without losing business.
The DOJ has also been criticized for defining markets too narrowly, another way of ignoring a merger’s customer benefits. For example, it blocked a 1998 Pennsylvanian bank merger, finding that the merged bank would hold a large market share and create anti-competitive effects in a narrow two-county area and separate “product markets” for checking and savings accounts. The Federal Reserve Board instead considered a nine-county area and single market for “commercial banking” services, finding the merger would increase consumer convenience and efficiency, outweighing anti-competitive harms.
In fact, for services like home loans, technological change means banks increasingly face competition from a large, nationwide market of other banks and non-bank lenders like financial tech companies.
Even if merger blockings fail in court, increased political pressure and the threat of DOJ litigation are likely to keep chilling merger activity, regardless of whether consumers would benefit. Simplifying regulations while culling those with costs that exceed benefits — and analyzing markets, competition and likely consumer outcomes based on concrete evidence rather than speculation — will foster competition while still allowing regulators to block mergers which are likely to leave Americans worse off.
Satya Marar is a visiting postgraduate fellow at the Mercatus Center at George Mason University, specializing in Innovation, Governance & Competition.