Academic journal article Federal Reserve Bank of New York Economic Policy Review

Banking and Securities and Insurance: Economists' Views of the Synergies

Academic journal article Federal Reserve Bank of New York Economic Policy Review

Banking and Securities and Insurance: Economists' Views of the Synergies

Article excerpt

PAPERS BY Anthony M. Santomero and David L. Eckles Randall S. Kroszner Cara S. Lown, Carol L. Osier, Philip E. Strahan, and Amir Sufi

COMMENTARY BY Christopher T. Mahoney



How do economists view the synergies between the banking, securities, and insurance industries? This timely topic was examined by three papers; comments by an industry analyst followed.

Overall, the presenters predicted further consolidation in the financial industry, each emphasizing different aspects of the benefits. Anthony Santomero and David Eckles argued in their paper that consolidation will benefit firms through revenue enhancement, rather than through cost reduction. The study by Cara Lown, Carol Osler, Philip Strahan, and Amir Sufi emphasized that banks merging with life insurance firms are likely to provide the biggest gains in terms of reduced bank risk. Lown et al. offered additional perspective by discussing the evolving "bancassurance" industry in Europe, while the paper by Randall Kroszner predicted that subsequent regulatory changes are likely to occur. Furthermore, Santomero and Eckles noted that arguments can be made both for and against the increased stability of the resulting financial system, and although systemic risk is an appropriate concern, enforcement of regulation, competition, and open markets can keep these issues at bay.

However, in his comments on the papers, Christopher Mahoney observed that with the likely emergence of large financial conglomerates, a policy of "too big to fail" may be an appropriate reaction to financial distress, despite growing political pressure to do otherwise.


Anthony Santomero and David Eckles discussed what is likely to happen in the financial sector in light of the recent regulatory and environmental changes that have occurred. The presenters began by discussing the impact that these changes would have on the operating scale of financial firms. They then reviewed five issues relating to firm size, beginning with operating costs. The existing literature, they observed, indicates that larger institutions may be more efficient in terms of average operating costs. Expenses may also be reduced if an institution can offer several products at a lower cost than separate competing institutions. Yet in reality there seems to be little cost improvement resulting from these economies of scale and scope. Santomero and Eckles argued that aggregating over many businesses adds a layer of complexity, with the result being that the overall cost structure does not seem to improve very much.

The second issue they addressed was revenue enhancement. Rather than cost savings, the driver behind mergers is the potential for additional revenue. To the extent that firms can cross-sell multiple products and that customers are willing to take additional products through the same channel, benefits associated with revenue can result. Santomero and Eckles' third issue with respect to firm size is that, for some businesses, size is necessary to be competitive. Because the nonfinancial industrial sector is consolidating, the scale of the business of finance is growing. Hence, by increasing its size, a financial organization can conduct an entire transaction on its own--something it otherwise could not have done. In other words, size itself has some positive attributes in the financial industry.

The last two issues concerned whether or not larger firms are inherently more stable. On the one hand, a greater number of businesses should, according to the law of large numbers, imply greater stability. On the other hand, the businesses typically are highly correlated, which can mitigate this law. Moreover, when there are a lot of businesses, something is likely to go wrong all the time. To the extent that this phenomenon occurs, a firm's value could be more unstable, rather than more stable. …

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