Magazine article Regional Economist

Regulators Always Have the Power to Pull the Plug

Magazine article Regional Economist

Regulators Always Have the Power to Pull the Plug

Article excerpt

Between 1990 and 2002, the total number of banks and thrifts in the United States fell from 15,131 institutions to 9,336. The foremost cause of the decline was a significant relaxation of U.S. bank branching laws, which allowed mergers and acquisitions that previously had been prohibited. Such mergers and acquisitions cannot take place, however, without the approval of a federal banking regulatory agency. (See table.) These banking regulatory agencies scrutinize proposed transactions to ensure that they do not violate any of the U.S. antitrust statutes.

The practice of antitrust analysis of bank mergers and acquisitions dates back to 1963, when the U.S. Supreme Court held that commercial banking, like other industries in the United States, is subject to the Sherman Antitrust Act of 1890 and the Clayton Act of 1914.1 In its opinion, the court noted that the test for anticompetitive behavior is whether the effect of a bank merger "may be substantially to lessen competition ... in any line of commerce in any section of the country."

Foundations of Antitrust

To apply this test, the court defined the "line of commerce" for the banking industry as the cluster of products and services-demand deposits, trust administration and extension of various types of credit, for example-that banks uniquely provide to their customers. In other words, the court determined that the products and services denoted by the term "commercial banking" compose a distinct line of commerce.

To define "section of the country"-that is, the relevant geographical market-the court looked to where the effect of a merger on competition would be "direct and immediate." For banking, this effect occurs in the customers' local communities because individuals and firms typically conduct the bulk of their banking transactions at banks with local offices.

A bank regulatory agency's final step is to determine whether the effect of the merger "may be substantially to lessen competition." In its ruling, the Supreme Court recognized that the answer to this question involved not only the immediate effects of a merger on competition, but also its anticipated future effects.2 Such a prediction relies on the structure of the relevant market-that is, market concentration, the market shares of individual banks and number of market competitors. Banking antitrust is based on the assumption that the structure of a market influences how firms in that market will act, which, in turn, affects the firms' overall performance (otherwise known as the structure-conduct-performance hypothesis). In other words, the merger's effect on these measures of structure, particularly market concentration, is thought to be a reliable gauge of whether the merger will lessen competition substantially. Therefore, a proposed merger that increases market concentration considerably would probably fail this test, and the federal regulator would not approve it. The federal regulator might approve it, however, if other evidence exists to mitigate the proposal's anti-competitive effects on market structure. That said, the Department of Justice could challenge the decision and possibly sue to prevent the merger.

Antitrust in Action: the Guidelines

To minimize the chances that a decision will be challenged and to align the antitrust analyses of the federal regulators, the Justice Department has periodically issued guidelines that define the circumstances under which an application is likely to exceed its antitrust standards and, therefore, warrant closer scrutiny. The federal banking regulators use these guidelines to help them identify proposals that are likely to raise concerns about adverse effects of mergers on competition.

The Justice Department's antitrust standards identify potentially anticompetitive mergers in terms of prescribed levels, and changes in levels, of a commonly used measure of market concentration, the Herfindahl-Hirschman Index (HHI). …

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