The Dollars and Sense of Bank Consolidation

Joseph P. Hughes
William Lang
Loretta J. Mester
Choon-Geol Moon

        For nearly two decades banks in the United States have consolidated in record numbers-in terms of both frequency and the size of the merging institutions.  Rhoades (1996) hypothesizes that the increased potential for geographic expansion created by changes in state laws regulating branching and a more favorable antitrust climate were the main factors behind the wave of bank mergers.
        To look for evidence of economic incentives to exploit these improved opportunities for consolidation, we use estimates of expected return, return risk, and profit efficiency based on a structural model of leveraged portfolio production that was estimated for a sample of highest level U.S. bank holding companies (BHCs) in Hughes, Lang, Mester, and Moon (1996).  Here, we also estimate two additional measures that gauge efficiency in terms of the market values of assets and of equity.  We examine how consolidation affects expected profit, the riskiness of profit, profit efficiency, market value, market-value efficiencies, and the risk of insolvency.
        Our findings suggest that the economic benefits of consolidation are strongest of those banks engaged in interstate expansion and, in particular, interstate expansion that diversifies banks' macroeconomic risk.  Not only do these banks experience clear gains in their financial performance, but society also benefits from the enhanced bank safety that follows from this type of consolidation.

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