Modernizing Bank Merger Review

Jeremy Kress is Assistant Professor of Business Law at the Stephen M. Ross School of Business at the University of Michigan. This post is based on his recent article. forthcoming in the Yale Journal on Regulation.

The biggest irony of the 2008 financial crisis is that the market crash was both initially triggered and ultimately alleviated by massive bank mergers. A wave of mergers by Bank of America, Citigroup, JPMorgan, and Wells Fargo in the late 1990s created the “too big to fail” banks that became so central to the crisis. Less than a decade later, the federal government orchestrated multibillion-dollar emergency acquisitions by several of these firms to stem the panic. Thus, these four dominant banks—which control forty-two percent of the assets in the U.S. banking system—owe their existence to megamergers. Now, critics worry that that these firms are not only “too big to fail,” but also “too big to jail,” “too big to manage,” and “too big to supervise.”

Of course, this is not the first time that bank mergers have raised public policy concerns. In the 1950s, for example, a massive merger movement sparked fears of then-unprecedented consolidation in the financial sector. Many of these deals did not require federal approval. Several years later, Congress established a comprehensive oversight regime for bank mergers in an attempt to rein in unregulated consolidation. Under the Bank Merger Act of 1960, banks would have to get approval from their federal regulators before combining.

This pre-approval system worked well for several decades. While the banking regulators signed off on the majority of merger applications, they regularly exercised their power to block transactions they determined would not be in the public interest. Policymakers, however, have allowed the once-powerful bank merger review process to atrophy over time, and the current framework is no longer adequate to safeguard modern financial markets. In many respects, the United States has reverted to pre-1950s policies favoring bank consolidation, thereby increasing risks to consumers and the broader financial system.

The Bank Merger Act and its companion statute, the Bank Holding Company Act, direct the federal banking agencies to consider four main factors when evaluating a proposed merger: (1) the proposal’s potential anticompetitive effects, (2) possible risks to financial stability, (3) the transaction’s probable effect on the public interest, and (4) the companies’ financial and managerial resources. The statutes authorize the agencies to reject a merger proposal if any one of these factors weighs against approval.

Although Congress instructed the banking agencies to consider multiple factors when reviewing bank merger proposals, legal scholarship on bank mergers has focused almost exclusively on just one: competition. Since the 1950s, dozens of law review articles have analyzed competitive considerations in bank mergers. Yet scholars have devoted virtually no attention to the other, equally relevant statutory considerations.

Thus, the legal literature has not assessed the extent to which the banking agencies have fulfilled their mandate to rigorously review merger proposals under all the applicable statutory standards. Recent evidence suggests that the agencies are falling short. Bank merger approval rates are at historic highs. The Federal Reserve, for example, signed off on 95 percent of merger applications in 2018—its highest approval rate since it began keeping track. Meanwhile, the agencies are greenlighting merger proposals at record speed. In the past, the banking agencies have taken nearly a full year, on average, to review bank mergers that attract adverse public comments. But in 2018, the Federal Reserve approved such applications in an average of four months. The agencies, moreover, have not formally denied a merger application in more than 15 years. Although by no means conclusive, this track record raises serious doubts about the efficacy of the agencies’ existing bank merger framework.

The agencies’ rubber stamping of bank mergers is deeply troubling. The weight of the available evidence suggests that bank consolidation hurts consumers and could imperil the financial system. By most accounts, for example, consolidation among large banks elevates risks to financial stability. Indeed, according to the Federal Reserve’s own research, distress at a single large bank poses a significantly greater threat to the economy than distress at several smaller banks with equivalent total assets. Meanwhile, large bank mergers pose serious integration risks and tend not to deliver promised efficiency gains or public benefits. Moreover, numerous empirical studies have found that bank mergers lower the availability and increase the cost of credit for borrowers, especially small businesses. And merging banks typically close branches, inconveniencing customers who rely on proximity to branch offices. In this light, the banking agencies’ recent track record of quickly approving nearly every merger proposal suggests that they are neglecting their responsibility to consider all the statutory factors as Congress intended.

My new article, Modernizing Bank Merger Review, urges the banking agencies to revamp their approach to mergers and acquisitions. In particular, the agencies should substantially enhance their scrutiny of bank merger proposals using the three statutory factors that to date have been overlooked in the legal literature—namely, financial stability, the public interest, and financial and managerial considerations.

First, the banking agencies should adopt quantitative systemic risk limits for bank mergers using commonly-accepted financial stability metrics. In the decade since Congress added the financial stability factor to the bank merger statutes, the agencies have relied on ad hoc assessments of a merged bank’s size, complexity, interconnectedness, and activities to determine whether a proposal would increase systemic risks. This approach, however, is rudimentary compared to the abundance of quantitative financial stability metrics—such as SRISK and the Basel Committee on Bank Supervision’s assessment methodology for global systemically important banks (G-SIBs)—that the agencies have incorporated into their regulations and supervisory practices. To ensure that bank consolidation does not threaten financial stability, the agencies should rely on a combination of these well-developed metrics to establish systemic risk limits for merger proposals.

Second, the agencies should demand more convincing evidence that a proposed merger will benefit the public. Despite their statutory mandate to consider “the convenience and needs of the community to be served,” the agencies’ public interest analyses are typically perfunctory and focus on advantages to the banks themselves—such as projected cost savings—rather than to their customers. Given the aforementioned negative consequences of bank consolidation, however, the agencies should begin reviewing a merger proposal with a presumption that the combination will not produce benefits to the public, absent strong evidence to the contrary. Similarly, the agencies should insist that bank merger applicants have outstanding records of serving low- and moderate- income communities under the Community Reinvestment Act. Finally, Congress should authorize the Consumer Financial Projection Bureau to block a bank merger on consumer protection grounds, similar to the Department of Justice’s power to prevent an anticompetitive bank merger.

Third, the banking agencies should strengthen the financial criteria they use to evaluate bank merger proposals. By law, the Federal Reserve may approve an interstate acquisition by a bank holding company only if the firm is “well capitalized.” Lawmakers insisted that acquiring BHCs have substantially more than the minimum amount of capital to provide a buffer against the uncertainties inherent in bank mergers. By regulation, however, the Federal Reserve has set the well-capitalized threshold just barely above its minimum capital requirements. The Federal Reserve should substantially increase its definition of “well capitalized” to ensure that only strong BHCs may expand via merger.

My article comes at a critical time. The Economic Growth, Regulatory Relief and Consumer Protection Act of 2018 weakened regulations on many of the largest U.S. banks, leading commentators to predict a wave of consolidation among regional banks. Shortly thereafter, regional banks BB&T and SunTrust announced a “merger of equals,” creating the sixth-largest bank in the United States—by far the biggest bank merger since the financial crisis. If approved by regulators, the BB&T-SunTrust deal is likely to trigger further consolidation among similarly-sized competitors. It is essential, therefore, that regulators enhance their scrutiny of bank merger proposals to ensure that future bank consolidation serves the public interest and does not increase risks to the financial system.

The complete article is available here.

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