Bank Mergers and the 'Curse of Bigness'

“Size, we are told, is not a crime. But size may, at least, become noxious by reason of the means through which it was attained or the uses to which it is put.” — Louis Brandeis

One of the challenges of dealing with financial institutions that are “too big to fail” is that the main deterrent to companies growing too large — antitrust law — is mostly useless. Government trustbusters examining the merger of two mega-banks focus on whether their union reduces competition and raises prices, not whether it threatens the financial system.

A curious state of affairs, given that a laissez faire disregard for industry consolidation in recent decades helped spawn the corporate behemoths presently throwing the financial universe out of kilter. It also leaves a vitally important question: How big is too big?

The answer isn’t simply a matter of tallying a company’s local market share. It requires making political and economic judgments (judgments, it’s worth noting, over which reasonable people may disagree).

Still, size matters. In 2000, the top five U.S. banks held 11 percent of all deposits, according to consulting firm Celent. By last year that figure had grown to 37 percent. While the biggest U.S. bank in 1995 had 2.7 percent of deposits, today three banks — Bank of America, JPMorgan Chase and Wells Fargo — exceed the FDIC’s national deposit cap of 10 percent. The top 10 banking companies have more than 40 percent of all deposits, according to the FDIC. The top four players control fully half of all bank assets, such as the capital used to make loans (click on charts to expand).

Should we care? Probably. As we’ve seen, big banks are being absorbed by even bigger ones (arguably to shore up the financial system). That pattern is likely to continue, as heavy losses claim more victims. The nation’s top antitrust cop, Christine Varney, herself has expressed concern, noting during her confirmation hearing in March that “I often wonder if antitrust has failed, if we’ve allowed institutions to be created that are too big to fail.”

There’s also the danger that the FDIC’s deposit insurance fund, already strained by the rising number of bank failures, could be swamped by the collapse of one of the larger institutions.

Some bankers, too, are worried. “The current crisis has made it painfully obvious that the financial system has become too concentrated, and — for many institutions — too loosely regulated,” Midsouth Bank CEO C. R. Cloutier said in a congressional hearing earlier this year on financial reform. Big banks also feel free to raise prices, circumstantial evidence that the industry is less competitive than its backers contend.

It’s not that bank consolidation is inherently bad. Until the 1970s, for example, banks were restricted from branching out nationally. In many parts of the country, the result was that customers had only one or two banks to choose from. The elimination of rules restricting branch banking and, in the 1990s, limiting bank mergers changed that, bringing competition to what were effectively monopoly markets.

The U.S. banking industry is also significantly less concentrated than those of other countries. In Canada, the top five banks have roughly 90 percent of the market. Measured by Herfindahl-Hirschman Index scores, a standard measure of market concentration, the banking sectors in France, Italy, Japan, Sweden and the U.K. are all more concentrated than in the U.S. (click chart to expand).

But the issue here isn’t whether the U.S. banking industry is sufficiently competitive — it’s whether a handful of institutions, by virtue of their disproportionate size and reach, undermine the smooth functioning of the system. How? By concentrating assets in a few institutions, raising the risks to all if they fail. By focusing political power in these companies. By distorting the markets, since the leviathans operate with an implicit government safety net, while smaller players are left dangling. And by encouraging the giants, seeking to grow ever bigger, to innovate themselves, and us, into trouble.

Defenders of the existing order will argue that big business, especially in a globalized age, demands big banks. There’s some truth to that. But there’s little reason to think that whittling these companies down would cripple them. Effectively restoring Glass-Steagall by partitioning them along business lines, or perhaps re-imposing geographic limits, would reduce risk and foster competitive balance. It’s also worth considering whether merger law should be changed so antitrust enforcers may take additional factors into account, such as whether a deal involving big banks makes the enlarged company financially vulnerable.

Such steps might go a long way toward finally lifting the “curse of bigness.”

Charts courtesy of Celent.