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Deregulation and structural change in the U.S. commercial banking industry

Eastern Economic Journal, Summer 2003 by Jeon, Yongil, Miller, Stephen M

INTRODUCTION

The twentieth century witnessed two periods of dramatic regulatory and structural change in the U.S. banking industry-the Great Depression and the various events of the 1980s and 1990s.1 While important regulations were enacted during the Great Depression, many of the financial regulations were repealed or reversed in the 1980s and 1990s. Moreover, during those two decades the banking industry changed from having extensive geographic limitations to being characterized by interstate banking and branching.

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The deregulation of intrastate and interstate banking and branching activities played a major role in the changing structure of the U.S. commercial banking industry. Our analysis follows two different, but complementary, paths-descriptive analysis that traces the trends in the changing structure of commercial banking and more formal analysis that considers the effects, if any, of deregulation on mergers, concentration, and net entries on a state-by-state basis.

The Federal Reserve Bank of Chicago recently posted on its web site the Report of Condition and Income (Call Report) and merger data for the period 1976 to 1998.2 That important source of data is now freely available to all interested parties. In the past, such data were only available at some real dollar cost to individual researchers. We employ those data to provide a panorama of structural change occurring over that period. Our description presents geographic patterns of change, largely on a state-by-state, and occasionally on a city-by-city, basis.3 Those data also provide the inputs for our more formal, econometric analysis that uses panel data to perform fixed- and random-effects estimation.

REGULATORY AND STRUCTURAL CHANGE: AN OVERVIEW4

Because our forefathers were concerned about concentrations of power, the U.S. banking industry possesses more independent institutions than most other coun-tries.5 The regulatory environment changed notably in the last twenty years, including, but not limited to, the Depository Institution Deregulation and Monetary Control Act of 1980, the Depository Institution Act of 1982, and the Interstate Banking and Branching Efficiency Act of 1994.

Throughout U.S. commercial banking history, banks could not operate across state boundaries either through interpretation of regulations or by explicit legislation. That legal and administrative landscape, however, possessed loopholes. Bank holding companies could acquire banks across state lines, if such actions were explicitly permitted by the states involved. That loophole was first mined in 1975 when Maine adopted legislation permitting out-of-state holding companies to acquire Maine banks, if reciprocity existed in the other state. But substantial movement did not really begin until 1982 when New York also passed reciprocity legislation and Massachusetts passed similar legislation restricted to the New England states. Most recently, the Interstate Banking and Branching Efficiency Act of 1994 permitted bank acquisitions in other states.6 State legislation has generally liberalized its rules on branch banking within states' borders.7 Legislative activity has gradually reduced the number of states to a very few that have either unit or limited branching.

Technological and financial innovations as well as the shifting interpretations of the relevant statutes by the numerous regulatory agencies eroded the original legislative intent of those statutes. Kane [1996] calls that erosion "statutory decay" and offers a public choice rationale that he terms "Regulatory Dialectic." In effect, the political process played an important role in explaining the evolution of regulation, its interpretation, implementation, and revision, and its ultimate demise.

A few authors forecast the future structure of the U.S. banking industry. Those analysts see a two-tiered system with a group of megabanks that participate in national and global credit markets and a much larger number of community banks that participate in local credit markets. For example, Miller [1988] forecasts just over 2,000 banks in a fully operating interstate banking and branching system.8 More recently, Berger, Kashyap, and Scalise [1995] provide a long-run forecast of between 2,000 to 4,000 banks under interstate banking and branching.9 Moreover, they forecast that the decrease in organizations should occur largely within five years. Our actual count of banks (not organizations) at the end of 1994 equals 11,698 (see Table 1). This count falls to 9,839 in 1998, or 84 percent of the 1994 level.10

Those last observations suggest that the consolidation in the banking industry may be proceeding more slowly than Berger, Kashyap, and Scalise [1995] projected. The growth of de nouo banks, and "new" banks by conversion and relocation explains the slower rate of consolidation. Between 1976 and 1998, the merger data at the Federal Reserve Bank of Chicago web site record 11,055 bank mergers (see Table 1). The number of banks did not fall from 15,264 to 4,209, but rather ended 1998 at 9,839. Over that same period, the merger data record 6,679 new banks-de novo, conversions, and relocations of head offices.

Deregulation and structural change in the U.S. commercial banking industry

Eastern Economic Journal, Summer 2003 by Jeon, Yongil, Miller, Stephen M

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