Academic journal article Federal Reserve Bank of St. Louis Review

Bank Competition and Concentration: Do Credit Unions Matter?

Academic journal article Federal Reserve Bank of St. Louis Review

Bank Competition and Concentration: Do Credit Unions Matter?

Article excerpt

Competition between banks and credit unions is interesting, in part, because it entails a for-profit sector (commercial banks) competing with a not-for-profit sector (credit unions). In addition, the distribution of market shares across financial intermediaries with different clienteles, service offerings, and cost structures may have implications for overall financial-sector efficiency. This article examines annual county-level observations of the concentration of commercial-bank deposit-market shares and household participation in occupational credit unions for the period between 1989 and 1996. We find empirical evidence that banks and credit unions directly affect each other's competitive positions in local deposit markets.

Previous research (Emmons and Schmid, 1999a) finds a link between the concentration of local commercial-bank deposit shares (as measured by the Herfindahl index) and indicators of credit-union efficiency (wage expense) and risk-taking (loan-loss allowances). [1] In addition, higher commercial-bank deposit concentration is associated with higher household participation rates--the fraction of those who are eligible and who choose to join--at credit unions (Emmons and Schmid, 1999b). Thus, competitive conditions among banks appear to influence the behavior of credit unions and their potential members. It has not been clear, however, whether the effects also run in the other direction--that is, whether credit unions affect the structure of local deposit markets that are dominated by commercial banks and thrifts.

The purpose of this article is to investigate the two-way interaction between banks and credit unions in local markets. Emmons and Schmid (2000) develop and analyze a dynamic model of spatial competition between banks and credit unions. There is no consensus in the literature about how best to model competition in financial services, so the model in that study provides a framework for making comparisons with other work. In this analysis, we provide a brief overview of the model in our working paper and provide empirical results from estimations of response functions of the local commercial-banking sector and of households (who comprise the credit unions).

CREDIT UNIONS AND COMPETITIVE ANALYSIS OF LOCAL BANKING MARKETS

There is a large and growing literature that investigates competition among banks (for example, see Berger, Demsetz, and Strahan, 1999; Amel and Hannan, 1998; or Prager and Hannan, 1998). Much less research focuses on the interactions between credit unions (or thrift institutions) and banks (Hannan and Liang, 1995). This section briefly discusses the bank-competition literature and asks whether credit unions are important for banking competition.

Banking Market Concentration, Prices, and Profits

Mergers among depository institutions and steady expansion of credit unions have been two hallmarks of the U.S. financial landscape in the 1980s and 1990s, but simply acknowledging these trends is not sufficient to characterize the evolution of competitive conditions in local deposit markets. The number of commercial-bank charters in existence has declined by between 3 and 5 percent annually since 1988, resulting in a nine-year (1988-97) cumulative disappearance of 33 percent of all bank charters (Berger, Demsetz, and Strahan, 1999, Tables 1 and 2). Mergers accounted for about 84 percent of disappearances and failures for 16 percent. Deposit-market concentration, however, actually declined slightly during this period. Average commercial-bank deposit Herfindahl indexes in metropolitan statistical areas fell from 0.2020 to 0.1949, and those in nonmetropolitan counties fell from 0.4316 to 0.4114 (Berger, Demsetz, and Strahan, 1999, Table 1). Meanwhile, credit-union membership grew more than 38 percent in the de cade ending in 1996, while the country's population grew about 10 percent (U.S. Treasury, 1997, p. 24).

Does market concentration matter for prices and profits? …

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