Too Many Bank Mergers Can Cause Problems, But a Michigan Ross Professor Proposes Some Innovative Solutions

Banks in the U.S. have been merging at a rapid pace in recent years, with regulators speeding up the approval process and making few or no denials. 

In a forthcoming paper in the Yale Journal on Regulation, Michigan Ross Professor Jeremy Kress argues that bank mergers deserve much more scrutiny than they're currently getting, and he details several innovative ways that could happen.

In a recent interview, Kress explained his proposals. 

Why are we seeing so many bank mergers lately?

Kress: There are a few reasons why mergers are spiking. Banks say they need to achieve scale in order to invest in information technology and cybersecurity. Many banks are just now escaping enforcement actions from the financial crisis, which frees them up to merge. And a bank deregulation law from last year incentivized firms to grow.

We experienced a similar merger wave back in the 1950s when banks were combining left and right, and Congress got really nervous about too much bank consolidation. So, in 1960, Congress passed a comprehensive pre-approval requirement for bank mergers. 

Over time, though, bank merger oversight has become a lot more lenient. Regulators have stopped denying bank mergers. We haven't had a bank merger denial in 16 years. I've got some data in the paper that show the regulators are rubber-stamping bank mergers today at record high rates and in record low time.

Why is this a problem?

Kress: There is significant evidence that bank mergers lead to higher prices for consumers, lower availability of credit, and lower rates on deposit accounts. 

The most significant effects are felt by small businesses because the smaller banks that tend to be gobbled up in these mergers are the ones doing the bulk of small business lending. 

If you own a small business, or if you're thinking of starting a small business, access to capital is going to be one of your greatest needs. If you don't have depository institutions that are interested in lending to you, that's going to be a deterrent to your growth or to even starting the company.

Then, there are additional negative effects on economic development when small businesses can't get access to the loans they need to grow. 

In the paper, you note that some of the negative effects of mergers particularly hit low- and moderate-income areas. Why is that?

Kress: Bank mergers result in fewer branches. Often, those branch reductions are concentrated in lower-income areas. In addition, as banks get bigger, they tend to have less interest in serving low- and moderate-income consumers, who tend to be lower-profit customers. 

As a result, check-cashing companies and other high-cost financial services providers proliferate in lower-income areas affected by bank mergers. When banks merge, households in lower-income areas are more likely to have debts sent to collection. At the most extreme, one famous study showed that bank mergers are associated with an increase in burglary and other property crimes. 

So today, regulators tend to focus on whether a proposed merger would reduce competition. Yet as you've explained, that's almost beside the point now.

Kress: Yes, traditional antitrust analysis has become increasingly irrelevant because two things have happened in financial markets since the 1970s: One, the geographic restrictions that used to prevent banks from expanding interstate have been eliminated. And two, banks now compete with non-bank financial services providers, particularly online. So if you look at the traditional metrics, banking markets are more competitive now than they have been in the past. Therefore, antitrust is no longer a meaningful constraint on bank consolidation.

You explain that regulators are legally bound to consider factors beyond competition, including whether a merger is in the public interest. What are you proposing in that regard?

Kress: First, I think regulators should start from the presumption that a bank merger will not benefit the public, given that mergers often lead to higher prices and less availability of credit. Regulators should insist on verifiable and quantifiable public benefits in order to approve a merger.

Second, regulators should look more closely at banks' performance under the Community Reinvestment Act, which requires banks to serve low- and moderate-income areas. Regulators have traditionally been deferential to banks that barely scrape by on this requirement. They could substantially increase their expectations.

Third, I strongly believe that the Consumer Financial Protection Bureau should have a say in bank mergers. The bureau is legally responsible for overseeing consumer compliance at large banks, but it doesn't have a voice in bank merger applications. So my recommendation is that Congress amend the bank merger statutes to require the CFPB to decide whether these banks have adequate consumer compliance systems in place to protect consumers as the banks grow. I just published an American Banker op-ed on this idea.

Are there other factors regulators are failing to consider?

Kress: Since 2010, regulators have been required to consider a merger's potential risk to the financial stability of the United States. But thus far, the financial stability analysis has been pretty rudimentary. There are useful quantitative metrics available to gauge threats to financial stability, but regulators aren't using them when considering bank mergers. The one that I highlight in the paper is a numerical metric developed by the Basel Committee on Bank Supervision. It is essentially a financial stability score. Regulators use that score for other purposes, like setting capital requirements. So I urge the regulators to establish cutoffs for financial stability risk in bank mergers using empirical metrics like the Basel Committee score.

Anything else?

Kress: The bank merger statutes say that regulators can only approve a bank merger if the resulting bank would be well-capitalized. That makes sense: Mergers inherently involve uncertainty, so consolidating banks should maintain a sufficient buffer to withstand unexpected challenges. The problem is that regulators have set the well-capitalized threshold so low that it has effectively no meaning. So my final recommendation is a significant increase in that well-capitalized threshold to ensure that merging banks hold substantially more capital than banks that aren't undergoing such expansion.

Jeremy Kress is an assistant professor of business law at the University of Michigan Ross School of Business. 

Read the full paper

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