Consolidation in the Banking Sector - Modern Banking

In most western economies, the trend is towards increased consolidation of banks and other financial firms. Consolidation is normally defined to include mergers: the assets of two or more independent firms are combined to establish a new legal entity and acquisitions: where one bank buys a controlling interest in at least one firm but their assets are not integrated, nor do they form a single unit. Firms may also enter into strategic alliances which are looser relationships but, as one study has shown (see below), can influence rival banks’ competitive behavior. Most of the literature focuses on mergers and acquisitions – M&As. In this area of banking, the consultant/academic literature is divided, with the consultants /practitioners tending to be strongly supportive of the process. After a merger or acquisition is announced, bankers emphasize the achievement of economies of scale and scope or synergy, and the improved shareholder returns that should follow, but rarely back it up with hard evidence.

Academics are more cautious because most of their studies using shareholder returns, performance and other measures give a less favorable verdict on the effects of M&As.

The Trends

Consolidation tends to be periodic. Everett (2003) documents general trends in mergers and acquisitions in the recent past. He identifies two waves of consolidation, in 1987–90and 1997–2000. In the first wave, 1987–90, 63% of M&As were in the manufacturing sector, 32% in the tertiary or services sector, and 5% in the primary sector. In the second wave, 1997–2000, 64% of M&As were in services and 35% in manufacturing. In both periods, within the service industry, a good proportion of the M&As were among financial institutions, especially between banks. Rhoades (1994), referring to the USA, noted a marked increase in bank merger activity in the early 1970s, then again in the late 1980s.

From the late 1980s to the new century, M&As in the banking sector enjoyed a prolonged boom in both the USA and Europe. To date, there have been few bank mergers in developing /emerging markets, except under duress.

Reasons for Consolidation in the Financial Sector

The reasons for mergers and acquisitions fall into three broad categories. The first is shareholder wealth maximization goals. If mergers lead to greater scale/scope economies and improved cost/profit X-efficiencies, the sector as a whole should become more efficient and create value, all of which benefits shareholders. However, consolidation invariably raises the degree of concentration, which could increase market power, leading to higher prices. While shareholders will still gain, consumers could be worse off. The second category is managerial self-interest: managers might see mergers as a way of enhancing or defending their personal power and status.

In the third category are a number of miscellaneous factors that create an environment favorable to M&As. They include changes in the structure of the banking sector, such as increased competition from non-bank competitors – as indicated by the decline in the banks’ share of non-financial short-term corporate debt, from about 58% in 1985 to around48% a decade later (Bliss and Rosen, 2001).

Changes in regulation may also be a factor. In the USA, changes to the Bank Holding Company Act in 1970, together with liberalization of state laws on the treatment of BHCs, increased merger activity. More recently, allowing commercial banks to have section 20subsidiaries, relaxing the laws on interstate branching, and the repeal of Glass Steagall, so that financial holding companies can have banking, securities and insurance subsidiaries, encouraged greater consolidation and nation-wide banking. In Europe, the Banking and Investment Services Directives, the introduction of the euro, and the Lamfalussy report should have encouraged greater integration of EU markets.54 Another factor is technological change, which (as was seen in an earlier section) has affected cost and profit X-efficiency, both by encouraging more revenue earning financial innovations (e.g. the derivatives markets) and cutting costs, such as the delivery of retail banking services. It is estimated that IT accounts for 15–20% of total bank costs, and is growing. Mergers can help control these costs and improve IT systems.

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