President Joe Biden signed a sweeping executive order on July 9, 2021, that aims to increase competition throughout the U.S. economy. In one of the order’s most significant provisions, he directed federal regulators to strengthen oversight of bank mergers.
As a former Federal Reserve attorney who is now a business law professor, I share Biden’s concern that widespread bank consolidation has hurt consumers and the broader economy.
If your bank has been acquired by a larger financial institution, you may have noticed that it is now harder for you to obtain a mortgage or a car loan or you may be earning less interest in your savings account and paying higher transaction fees.
Biden’s executive order aims to reverse these troubling trends. But with the pace of bank mergers accelerating as the economy recovers from the coronavirus pandemic, putting the brakes on harmful consolidation will not be easy.
From 1934 until the 1980s, the U.S. banking system consisted of more than 18,000 primarily small depository institutions.
Today, however, the number of banks in the United States has plummeted to fewer than 5,000, while concentration among the largest lenders has reached record levels. The top four banks – JPMorgan, Bank of America, Wells Fargo and Citibank – hold the same amount of assets as the next 300 combined, about US$9 trillion.
Three distinct waves of bank mergers have contributed to the rapid consolidation of the U.S. banking sector.
First, in the 1980s and 1990s, policymakers repealed longstanding geographic restrictions that had limited banks to operating within a single state. Once banks were allowed to expand across state lines, many merged with lenders in neighboring states, creating a cohort of larger, regional banks.
Next, banks began to grow not only in size, but also in scope. In 1999, the Gramm-Leach-Bliley Act eliminated Great Depression-era restrictions on activities like investment banking and selling insurance. Many banks expanded into these new activities through mergers, such as Citicorp’s acquisition of Travelers insurance company and Chase Manhattan Bank’s combination with investment bank J.P. Morgan.
The third wave of bank mergers began during the 2008 financial crisis, when several financial giants acquired failing firms, often with government assistance. JPMorgan Chase acquired Bear Stearns and Washington Mutual, Bank of America absorbed Merrill Lynch and Countrywide and Wells Fargo merged with Wachovia. These crisis-induced mergers created the behemoth financial conglomerates that dominate the U.S. financial sector today.
Now a fourth wave may be underway, triggered by Trump-era financial deregulation that made it easier for banks to get bigger. COVID-19 has also contributed to bank consolidation. The Fed responded to the pandemic by setting interest rates near zero, which has made it harder for banks to earn profits off lending and has encouraged more mergers.
In other words, this recent trend shows few signs of slowing down anytime soon.
For example, bank mergers increase the cost and reduce the availability of consumer financial services. Bank mergers often lead to branch closures, inconveniencing customers. The negative effects of bank consolidation are especially pronounced in poorer neighborhoods, where high-fee check-cashing companies and other predatory financial service providers proliferate following bank mergers.
Small businesses also suffer when banks merge. With fewer banks competing in a given market, small business lending declines significantly following a merger. For small businesses that are able to get loans, credit becomes more expensive and average loan size shrinks. As a result, fewer entrepreneurs start small businesses after banks consolidate.
Post-merger declines in small business lending and formation also have detrimental effects on economic development. For example, with fewer small businesses, bank mergers have been associated with decreases in commercial real estate development, new construction activity and local property prices.
Meanwhile, fewer small businesses leads to fewer good jobs. Indeed, in areas affected by bank mergers, unemployment has increased, median income has declined and theft has become more frequent.
Finally, big bank mergers increase the risk of another financial crisis. Numerous empirical studies have demonstrated that large bank mergers threaten financial stability. When banks grow through mergers – as many did in the runup to the 2008 crisis – the consequences of their failure become more dire.
Bank consolidation, of course, is not always bad. Some bank mergers – particularly among community banks – can reduce banks’ costs without harming consumers or endangering the financial system.
In my opinion, however, bank regulators – who have to approve all mergers – have failed to differentiate innocuous bank mergers from those that are likely to hurt consumers.
In 1960, the Bank Merger Act directed federal bank regulators to consider the public interest when deciding whether to approve or deny a bank merger. It also authorized the Department of Justice to block a merger that substantially lessens competition.
At first, regulators regularly rejected bank mergers. From 1972 to 1982, for example, the Federal Reserve denied more than 60 merger proposals.
Over time, however, regulators have become far more deferential to banks that want to merge. According to my research, the Federal Reserve has now approved more than 3,500 consecutive merger applications since 2006 without issuing a single denial.