Antitrust in the U.S. Banking Industry

1. Antitrust in the U.S. Banking Industry Robin A. Prager Board of Governors of the Federal Reserve System November 30, 2007

2. Antitrust Authorities • Department of Justice • Bank Regulators • Federal Reserve Board • Office of the Comptroller of the Currency • Office of Thrift Supervision • Federal Deposit Insurance Corporation

3. Sources of Authority • DOJ • Sherman Antitrust Act of 1890 • Clayton Act of 1914 • Bank regulators • Bank Merger Act of 1960 • Bank Holding Company Act of 1956

4. Merger Guidelines • Issued by Federal Trade Commission and Department of Justice • Outline method for evaluating horizontal mergers: (1) define relevant geographic and product markets (2) calculate structural effects using HHI (3) if structural effects indicate that merger raises potential competitive concerns, consider other factors

5. Market Definition: SSNIP Test “A market is defined as a product or group of products and a geographic area in which it is produced or sold such that a hypothetical profit-maximizing firm, not subject to price regulation, that was the only present and future producer or seller of those products in that area likely would impose at least a "small but significant and nontransitory" increase in price …. A relevant market is a group of products and a geographic area that is no bigger than necessary to satisfy this test.” U.S. Department of Justice and the Federal Trade Commission, Horizontal Merger Guidelines

6. Implementing the SSNIP Test • Econometrically estimate demand system for smallest possible set of products to be considered • Use demand estimates, together with information about merging firms’ cost functions and current prices of all products in the set, to determine whether monopolist of that set of products could impose significant price increase • If no, look at broader set of products • If yes, then set of products is deemed to comprise a market

7. Implementing the SSNIP Test, cont’d. • Process can be complicated – especially when the number of products being considered is large • Recent innovations in econometric estimation of demand systems have made this more tractable (e.g., Berry, Levinsohn, and Pakes (1995); Hausman, Leonard, and Zona (1994)) • However, data requirements can still be quite substantial • DOJ and bank regulators have developed streamlined approaches for defining geographic and product markets in banking

8. Geographic Markets • Scope of geographic market may vary considerably across banking products and banking customers • Market for providing loans to large national or multinational corporations is almost certainly national or global in scope • Market for providing retail banking services (e.g., transactions accounts and small loans) to households and small businesses is much smaller in geographic scope

9. Geographic Markets, cont’d. • U.S. antitrust authorities focus primarily on retail banking services (but there are exceptions) • Geographic markets for retail services are defined as economically integrated local areas • a metropolitan area • a single rural county • two or more contiguous rural counties

10. Geographic Markets, cont’d. • Some researchers (e.g., Radecki (1998)) have argued that internet banking and other recent developments have rendered the concept of local banking markets obsolete • Evidence from surveys (e.g., SSBF and SCF) and research studies (e.g., Heitfield (1999); Heitfield and Prager (2004)) continues to support existence of local retail banking markets

11. Product Markets • Traditionally defined by antitrust authorities and the courts to consist of cluster of products and services provided by a commercial bank • Courts have explicitly rejected idea that each product line (e.g., transactions accounts, savings accounts, mortgage loans) is a separate product market • Evidence from surveys (e.g., SSBF and SCF) provides weak support for the concept of the cluster

12. Product Markets, cont’d. • Total deposits in the relevant geographic market are used as a proxy for the bank’s capacity to provide the cluster of commercial banking products in that market • Deposits make up the bulk of a bank’s liabilities • Funds are fungible across different types of assets • Deposits are the only product for which data are available at bank branch level

13. Competitive Analysis • Competitors considered are commercial banks and thrifts with a branch presence in the local market area • FRB typically gives thrifts 50% weight in structural calculations; if thrift is active commercial lender it gets 100% weight • DOJ gives thrifts either zero weight or 100% weight, depending on level of commercial lending activity • Recent research on market segmentation supports differential treatment of banks and thrifts (e.g., Adams, Brevoort and Kiser (2007); Cohen and Mazzeo (2004))

14. Competitive Analysis, cont’d. • Nonbank providers of financial services (e.g., credit unions, finance companies) are generally excluded from structural calculations • Less stringent guidelines for banking than for other industries indirectly account for their presence (200/1800 for banking vs. 50/1800 or 100/1000 for other industries) • DOJ sometimes includes credit unions in its calculations

15. Competitive Analysis, cont’d. • If transaction would increase the HHI by more than 200 points to a post-merger level above 1800, or would result in a market share greater than 35% for the merged entity, it receives further scrutiny • Consideration is given to presence of credit unions • Potential entry is taken into account by considering factors (e.g., recent past entry, recent population growth) that are thought to affect the likelihood of future entry • Recent study (Adams and Amel (2007)) supports use of these factors as predictors of future entry

16. Competitive Analysis, cont’d. • If proposed transaction raises significant competitive concerns when all relevant information is taken into account, applicant often proposes divestiture that alleviates concerns

17. Nationwide Deposit Cap • Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 prohibits approval of an interstate acquisition if, on consummation of the transaction, applicant would control more than 10 percent of total deposits of insured depository institutions in the U.S. • No room for discretion here

18. Nationwide Deposit Cap, cont’d. • For vast majority of transactions, nationwide deposit cap does not come close to being a binding constraint • For example, as of June 30, 2007, the only transactions that would have been prohibited by the 10 percent cap would have been: • the largest bank, in terms of domestic deposits acquiring numbers 2 through 15 • the second largest from acquiring numbers 3 through 6 • In recent years there have been only a few transactions (all of them involving Bank of America) that were “close calls,” but in each case the Board’s calculations showed that the cap would not be violated upon consummation of the deal

19. How are we doing? • Very few bank mergers have been denied by U.S. antitrust authorities in recent years • This does not necessarily imply antitrust policy towards banking has been ineffective • Federal Reserve Board has made conscious effort to communicate to the banking community the standards applied in evaluating bank merger applications • This approach has probably discouraged quite a few seriously anticompetitive potential mergers from ever being proposed

20. Criteria for Evaluating Antitrust Policy (1) Should permit those mergers and acquisitions that would enhance efficiency without harming competition (2) Should prohibit those mergers and acquisitions that would substantially reduce competition in any relevant market

21. Evaluating Merger Policy • Our policy has allowed substantial consolidation of the banking industry to take place • More than 4,200 bank mergers involving acquired assets in excess of $4.2 trillion were completed between 1994 and 2006 • Number of banks and thrifts chartered in the U.S. declined from about 13,300 as of year-end 1993 to about 8,700 as of year-end 2006, primarily as a result of mergers and acquisitions

22. Evaluating Merger Policy, cont’d. • Despite this massive consolidation at the national level, there has been no increase in average concentration in local banking markets – indeed, there has been a slight decline in concentration in rural markets, while urban market concentration has remained virtually unchanged

23. Average Local Market Concentration

24. Conclusion • Our approach to banking antitrust, though not perfect, seems to perform pretty well • FRB staff continue to • Conduct research, and review the research of others, that sheds light on the evolving structure of the U.S. banking industry and its implications for antitrust policy • Reassess, on an ongoing basis, the appropriateness of our approach