Consolidation in Banking and Financial Services: The Demise of Glass-Steagall

By Soper, John C. | Journal of Private Enterprise, Spring 2001 | Go to article overview

Consolidation in Banking and Financial Services: The Demise of Glass-Steagall


Soper, John C., Journal of Private Enterprise


What is the long-run equilibrium structure of the banking industry after the termination of the Glass-Steagall Act? Obviously we do not know the answer to this question now, but some intelligent speculation may illuminate our thinking about this question and lead us to some useful predictions about the future shape of the U.S. banking industry. In addition, there may be implications both for the more broadly defined financial services sector and for the regulatory apparatus that seeks to control banking and financial services in general.

Consolidation in the U.S. banking industry has resulted in a decline by more than forty per cent in the number of banks since 1984 (Gunther, 1996).1 Although there appears to be a reduction in the rate of consolidation dating from mid-1998, the recent termination of most of the regulatory provisions of the Glass-Steagall Act of 1933 suggests that the banking industry is likely to see significant additional consolidation in the near future, say over the next decade. The United States still has a very large number of banks (8,604 as of September 30, 1999). This makes it likely that many of these institutions will find merger partners in the banking sector or in the broader financial services sector-including insurance firms, brokerages, investment banks, etc. Mergers of banks with other banks mean consolidation. Mergers of banks with non-bank financial service providers mean convergence.

Dominant factors

A number of issues emerge in the consideration of the expected continuation of bank merger and acquisition activity. High on the list of important issues is what factors are likely to dominate in future bank mergers and acquisitions, in the long run and in the short run?

In their 1996 article, Spiegel and Gart listed a number of factors motivating bank merger and acquisition activity:

* Revenue growth from a larger customer base;

* Efficiencies in operations;

* Ability to spread fixed costs over a larger customer base;

* Diversificationof income from both products and geographic area;

* Stabilization of asset quality;

* Optimal deployment of excess capital; and

* The search for higher value of common shares.

To these we might add another factor seldom mentioned to shareholders: fear. That is, management fear of being acquired by a larger and/or more aggressive bank, or fear of becoming "a bit player" in a field of giants. Furlong (1998) has added the motivating factor of attempting to achieve a higher valued output mix through merger activity. Akhavein, et. al. (1997) found evidence of this result for mergers in the 1980's, while Berger (1998) extended the findings to include mergers in the 1990's. Both of these studies conclude that merged banks have enhanced their output mix by shifting the composition of assets from securities to higher yielding loans. It also appears that merged banks were able to lower the cost of borrowed funds. Perhaps this was due to the reduction in risk through diversification (both in terms of geographic extent and in terms of product mix) and risk reduction through diversification of earnings. The most significant source of earnings diversification is increases in fee income relative to traditional interest income.

In a recent paper revisiting mergers of publicly traded banking firms between 1989 and 1999, Kwan and Eisenbeis (1999) examined 3,844 merger transactions. They list three reasons for the surge in acquisitions: (1) to achieve cost savings and/or operational efficiencies; (2) to be better able to compete in the global marketplace; or (3) to provide for the controlled exit from the financial services industry of inefficient competitors. Their findings indicate that the widely touted earnings, efficiency, and other performance and earnings benefits of large bank mergers remain largely in doubt.

Historically, bank merger and acquisition activity began to turn up as a result of bank failures in the 1970's and 1980's. …

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