By Hu Benton
ABA Viewpoint
In 1995, President Clinton was running for reelection, Toy Story was tops at the box office, the world was transfixed by the O.J. Simpson murder trial and the federal government updated the regulatory guidelines it uses to assess proposed bank mergers. While much has changed since 1995 for Bill Clinton, Buzz Lightyear, and the many famous faces from the O.J. trial, the competitive analysis the government uses to review bank combinations remains virtually the same.
That last bit needs to change.
Given the dramatic developments in the financial services marketplace since 1995, particularly the growth of nonbank players and online banking, we need to update bank merger rules if we want to give the nation’s existing banks the chance to succeed and compete.
What’s the test?
Before we dive into the problems with the 1995 rules, here’s a quick reminder of the government’s current bank merger test.
Federal law provides a long list of issues that authorities (namely the Department of Justice and the bank regulatory agencies) must consider in reviewing bank mergers:
- A merger’s potential impact on competition
- The merged bank’s expected financial and managerial resources (capital, liquidity, management experience, and competence)
- The convenience and needs of the relevant communities
- The institutions’ track records under the Community Reinvestment Act and anti—money—laundering laws
- The possible impact of the merger on U.S. banking and financial stability
What’s the problem?
There are several areas where the current framework falls short. First, the regulatory guidelines for merger competitive analysis do not reflect the reality of the bank marketplace today. Under existing guidelines, deposit market shares are determined primarily by reference to physical branches located in the relevant geographic markets. If the projected combined branch deposit shares of two banks exceed certain mathematical thresholds, the merger will likely be rejected as anti — competitive or approved only if the banks make major changes to their footprints.
Since 1995, the market for financial products and services has seen the expansion of online banking, the interstate growth of bank branch networks, and the growing market presence of nonbank financial firms, including fintechs, credit unions, and Farm Credit System institutions. Banks can sometimes document this broader competition in their markets, but the regulatory review normally takes no account of nonbanks, nor of competition from other banks’ online channels. This makes no sense because it ignores a major part of modern reality.
Similarly, two of the other required factors have particular policy implications: the institutions’ record of Community Reinvestment Act compliance and serving community needs, and the effect of the proposed merger on U.S. financial stability. The agencies’ assessment of these factors is also evolving, but clarification and transparency remain distant aspirations. Among other things, updated standards for community impact could reestablish the right balance between appropriate community input in the merger application process (which sometimes amounts to form letters submitted multiple times by outside groups) and the need for prompt, transparent review of merger applications.
Why does it matter?
Effective, appropriate bank merger policy is important to the health of the U.S. financial system and economy. Banks in all markets face increased pressure to make ongoing investments in technology (for improved customer service and cybersecurity) and in compliance infrastructure (people, software, education and training). Some banks may find a merger and the resulting economies of scale to be the most efficient way to meet these requirements.
Moreover, a narrow, outdated view of competition is unreasonably restrictive and may cause irrational outcomes. For example, if two community banks have most of the branches in their geographic market (as pre-defined by the Federal Reserve Board), they likely cannot merge under current standards because the merger would produce excessive market concentration. As noted, the regulators often fail to consider additional competition from credit unions and other nonbank competitors or from online service delivery by banks that have no local branches, so real competition is often greater than the current test recognizes.
But if instead one of the banks is willing to combine with a larger, multistate institution that has no presence in those markets yet, that transaction could be approved (all other things being equal) because it would be viewed as leaving two viable competitors in the local market. The same could happen if a local credit union proposed to acquire one of the banks, prolonging the fiction that banks and credit unions still shouldn’t be considered competitors.
Some critics point to recent events to urge regulatory caution — citing the bank failures in 2023 as warning signs. It’s worth remembering that then-Treasury Secretary Janet Yellen pointed out that mergers offer one way of strengthening struggling banks before they fail (a situation the law specifically contemplates in connection with analyzing competition; the standards for assessing future prospects and resources still apply). Others point to recent industry consolidation trends as a reason for merger skepticism. But potential economies of scale are a powerful counter in a long period of increasing (and increasingly expensive) investment in both technology and compliance infrastructure, as well as a measure promoting health of the affected banks. And, as my ABA colleagues have previously pointed out [1], policymakers and the industry have another tool for fighting consolidation if they want to use it: they could increase the frequency and ease of de novo bank formation and approval. Today it’s simply too hard to open a new bank in this country.
What to do?
The federal banking agencies and the Department of Justice have begun a public discussion about updating merger policy, but much work still lies ahead. New policy statements in 2024 from the OCC and the FDIC were offered as progress, but neither provided much of an update on competition assessments. Both in different ways would have increased the burdens of the application process, as well as created new uncertainties about what banks could expect to get approved. As anyone who has ever worked for a company trying to merge can attest, while deals are pending there is apprehension among staff, potential confusion among customers and the public and often a hold on other plans and projects while regulators make up their minds.
The FDIC’s new leadership has withdrawn its 2024 version and President Trump recently signed a Congressional Review Act resolution adopted by lawmakers in the House and Senate reversing the OCC’s rulemaking.
Now is the time to move forward.
We’re hopeful the new regulators will adopt more prudent rules that allow banks to combine when those combinations make sense in today’s highly competitive financial services marketplace. If they are unable to reach consensus, we know that Congress has shown interest in fixing the bank merger regulatory landscape.
Not every bank will seek a merger, but probably every senior banker will consider one eventually, and probably more than once. The health of their institutions requires a stable, transparent regulatory regime under which decisions are predictable and prompt. Even if we had that in 1995, we don’t today, and consumers as well as banks are paying a price for that.
[1] https://www.aba.com/advocacy/policy-analysis/aba-letter-of-support-re-hr-478
ABA Viewpoint is the source for analysis, commentary and perspective from the American Bankers Association on the policy issues shaping banking today and into the future. Click here to view all posts in this series.
