The incredible shrinking U.S. banking industry


The U.S. banking sector is beginning its long-anticipated consolidation.  Will this be a good thing for consumers and corporations?  A number of Professors at the Wharton School recently weighed in on this question.

According to the Federal Deposit Insurance Corporation, the U.S. banking sector is expected to end up with 6,529 commercial banks and 1,128 savings institutions by the end of 2011.  This represents a 4.4% decline from 2010, leaving the country with nearly half as many institutions as it had 20 years ago.

Compared to earlier times, most of the consolidation has been due to failures as opposed to higher M&A activity.  This failure rate has many causes including reduced economic activity, escalating costs and higher bankruptcy and foreclosure rates.  For many of the failures, the coming of the recent Dodd-Frank Wall Street Reform and Consumer Protection Act had been the final nail in the coffin.  This legislation stipulated higher capital, liquidity and leverage requirements as well as significantly tougher regulatory controls.  Smaller banks, particularly those with less than $500M of assets, have suffered the most with many experiencing valuation declines.  

Most experts believe consolidation will continue for the foreseeable future.  They differ, however in the implications for businesses and consumers as well as the banks themselves.

A modest to positive impact…

Concentration in itself is not necessarily bad.  “We don’t really need as many banks as we used to,” says Jack Guttentag, Wharton professor and former economist at the Federal Reserve Bank of New York. “Banks now have the power to [set up branches] wherever they want to, so what really matters is how many options a customer has in a certain market.”

As well, there is the argument that a smaller number of larger banks can improve their global competitiveness by leveraging scale economies in areas like IT, distribution and Capital Markets.  And, higher scale economies also have the potential to reduce the overall cost of banking much like Walmart achieved in retailing.

…Or less choice and control

Not all customers and markets will benefit from greater consolidation. Businesses and consumers will be uneasy in an environment where a handful of banks dominate the market of certain types of products or markets. As an example, Four “mega banks” – Bank of America, Citigroup, JPMorgan Chase and Wells Fargo – now hold 60% of the U.S. home mortgage market.  According to Guttentag, “It’s a textbook issue of a concentration of power. A limited number of firms control the market, and they will engage in implicit collusion” with negative implications on pricing, service and product availability. Business concern around oligopolistic behaviour was not uncommon in Canada where the market was served at one time by only a handful of large chartered banks and small credit unions.

A declining number of low-cost and local U.S. community banks may offer fewer choices for currently under-served customers such as small business, rural and lower income group segments. Furthermore, some geographies may end up with just one dominant bank. “There are a few markets in danger of becoming a one-bank or two-bank town,” say Ken Thomas, a Professor at Wharton. For example, in the Pittsburgh metropolitan area, PNC Bank has 47% of the deposit share, according to the FDIC.

Market opportunity?

Growing consolidation offers many opportunities for the bold and well capitalized:

  1. The current economics of banking will result in lower (short term?) valuations for many U.S. banks.  Well-heeled banks, especially Canadian ones, could take advantage of this opportunity by ramping up M&A activities;
  2. Consolidation will not be good news for many small businesses or millions of people (e.g., immigrants, students, working poor) who may not fit into the marketing plans of the larger banks. This ‘under-banked’ sector is a potentially large market for non-traditional financial institutions like Canada’s Money Mart or ING whose business model is a good fit with this segment.
  3. Increased concentration may end up delivering the scale needed by small to medium size banks to justify large IT, product and risk management investments.

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1 comment so far

  1. […] and steadily increasing compliance and technology costs makes the fragmented HNW sector ripe for further consolidation. However, this strategy will only pay dividends only if the acquisition can be profitably […]


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