Financial Industry Megamergers and Policy Challenges

By Hoenig, Thomas M. | Economic Review - Federal Reserve Bank of Kansas City, Third Quarter 1999 | Go to article overview

Financial Industry Megamergers and Policy Challenges


Hoenig, Thomas M., Economic Review - Federal Reserve Bank of Kansas City


In the past few years, the pace of consolidation in the banking industry has accelerated, and combinations between banks and other financial service providers have become increasingly prevalent. In some countries, consolidation has resulted from the need to eliminate weak or problem institutions. More generally, however, the unprecedented wave of merger activity in financial services is being driven by powerful changes in telecommunications and information technology and by the removal of legal and regulatory barriers to national and international linkages. An important recent development is a change in the scale of financial industry mergers. Indeed, the size of these business combinations has increased to the point that, both in the United States and Europe, "megamergers" are reshaping the structure of the financial services industry. Financial megamergers raise a number of important public policy issues. Some of these issues are very familiar and apply equally to megamergers and to more traditional mergers between financial service providers. For example, regulatory approval of megamergers may depend on antitrust implications and industry concentration. However, the rise of banking and financial industry conglomerates brings into sharper focus a long-standing concern not addressed in existing merger guidelines. In a world dominated by mega financial institutions, governments could be reluctant to close those that become troubled for fear of systemic effects on the financial system. To the extent these institutions become "too big to fail," and where uninsured depositors and other creditors are protected by implicit government guarantees, the consequences can be quite serious. Indeed, the result may be a less stable and a less efficient financial system. In my remarks, today, I will focus on the challenges posed by financial industry megamergers and examine some possible policy options currently under study. My discussion will begin by briefly reviewing consolidation trends and the rise of megamergers. I will then highlight some of the policy issues raised by megamergers and discuss some of the policy alternatives under review Not surprisingly, there are no easy answers to the challenges accompanying the advent of megamergers. I am decidedly less optimistic than some about whether we will, in the end, be able to rely sufficiently on market discipline to correct for potential distortions stemming from government guarantees. I suspect we will inevitably find ourselves having to deal with an institution that is too big to fail and, over time, relying more heavily on regulation and prudential supervision to oversee activities. Part of our challenge is to outline how we might in the future deal with "too big to fail" as we attempt to balance the economic benefits of consolidation against the potential costs to the financial system.

I. THE RISE OF MEGAMERGERS

In the United States and other industrialized countries, consolidation in financial services is occurring along three dimensions: within the banking industry, between banks and other financial service providers, and across national borders. To date, much of the consolidation has happened within the banking industry. In the United States we have seen the number of banking organizations fall from around 12,000 in the early 1980s to about 7,000 organizations today, a decrease of over 40 percent. In European countries, where the number of banks is much smaller than in the United States, a similar trend nevertheless is apparent. There are also growing linkages between banks and other financial service providers. In the United States and Canada, there has been a trend toward consolidation of commercial banking and investment banking operations. In Europe, where the universal banking model is more prevalent, the trend has been to combine banking and insurance activities. While much of the consolidation, thus far, has occurred within domestic financial markets, there are signs of increased cross-border activity as well. …

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