Bank Consolidation, Deregulation, and Financial Risk in the US
This paper examines the successive waves of consolidation among U.S. financial institutions, tracing the role of deregulation — particularly the repeal of the Glass-Steagall Act in 1999 — in enabling mergers between commercial and investment banks. It considers the benefits of consolidation, including economies of scale, improved consumer access to nationwide banking services, and greater capital access. It also analyzes the significant disadvantages, most notably the systemic risk created when investment and retail banking operations became intertwined, contributing to the conditions that intensified the 2008 financial crisis. A comparison with Canada's more regulated banking sector underscores the argument that cross-sector consolidation poses meaningful risks to consumers and taxpayers alike.
- Introduction: Drivers of Financial Institution Consolidation: Common factors driving financial sector mergers and acquisitions
- Deregulation and the Growth of National Banking: How deregulation enabled cross-state and cross-sector banking
- Consumer Benefits of Bank Consolidation: Scale, access, and consumer advantages from larger banks
- Risks and Consequences of Cross-Sector Mergers: Securitization, systemic risk, and the 2008 financial crisis
- Conclusion: Weighing Consolidation's Costs and Benefits: Balancing intra-sector benefits against cross-sector dangers
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What makes this paper effective
- Uses a clear cost-benefit structure that moves logically from the causes of consolidation to its benefits and then to its risks, making the argument easy to follow.
- Grounds abstract economic concepts — such as securitization, liquidity traps, and HHI — in concrete historical events, particularly the 2008 financial crisis.
- Employs an effective comparative example: Canada's retention of banking sector separation is used to illustrate what the U.S. might have avoided, strengthening the causal argument.
Key academic technique demonstrated
The paper demonstrates comparative institutional analysis — contrasting U.S. and Canadian banking regulation to isolate the effects of cross-sector consolidation. By pointing to Canada as a natural control case, the author moves from correlation toward a more persuasive causal claim about the dangers of repealing Glass-Steagall.
Structure breakdown
The paper opens by surveying the common drivers of financial consolidation, then narrows to the U.S. regulatory context and the role of deregulation. Two body sections weigh the consumer benefits (scale, access, mobility) against the systemic risks (misallocated risk, securitization, crisis exposure). The conclusion synthesizes both sides, endorsing intra-sector consolidation while cautioning against cross-sector mergers, particularly between retail and investment banks.
Introduction: Drivers of Financial Institution Consolidation
Successive rounds of consolidation among financial institutions have been attributed to a number of factors. Most of these factors are fairly common in merger and acquisition activity, so in that sense the financial services industry is not unlike other industries. Efficiency improvements are one key driver; increases in market power, diversification of revenue streams, and lowering risk are all factors commonly cited in such mergers (Berger, Demsetz & Strahan, 1999). Understanding why banks merge — and what consequences follow — is essential to evaluating the overall health and fairness of the financial system for consumers and taxpayers alike.
Deregulation and the Growth of National Banking
Successive waves of deregulation allowed for a much greater degree of consolidation among U.S. financial institutions. First, banks were permitted to operate across state lines, which enabled the growth of national-level retail banks in the United States. By 1999, the Glass-Steagall Act was repealed. This Act had created a separation between commercial banks and investment banks. With that restriction eliminated in 1999, there was further consolidation as these two types of financial institutions began to explore mergers and acquisitions as a means of further diversification (Investopedia, 2014).
Consumer Benefits of Bank Consolidation
For banks, the ability to merge has allowed them to grow into much larger institutions. Several retail banks have been able to expand into very large, in some cases nearly national, banks. This increase in scope has given them greater access to capital, greater economies of scale, and — for consumers — better access to nationwide service. By the 1990s, it had become evident that the fragmented nature of the U.S. banking industry was doing consumers a disservice: other nations were innovating because their banks had scale. U.S. consumers have benefitted from being able to keep their bank accounts when they move across the country and from having much greater access to services.
Conclusion: Weighing Consolidation's Costs and Benefits
The evidence from U.S. activity of late shows that consolidation within a particular banking sector is generally good for consumers, at least to the extent that the industry maintains a low HHI, because it allows for the creation of scale advantages and banks that can operate across state lines. While the growth of financial institutions that can operate across multiple financial industries is not inherently bad for consumers, it took very little time after the repeal of Glass-Steagall to produce the largest financial crisis since that Act was originally created. De facto, consolidation between investment and retail banks tends to create the sort of misallocation of risk that is detrimental to consumer interests — especially in times of crisis — and certainly to taxpayers, who ultimately end up underwriting the financial system.
References
Berger, A., Demsetz, R., & Strahan, P. (1999). The consolidation of the financial services industry: Causes, consequences and implications for the future. Journal of Banking and Finance, 23, 135–194.
D'Souza, C., & Lai, A. (2010). The effects of bank consolidation on risk capital allocation and market liquidity. Bank of Canada. Retrieved December 7, 2014, from http://www.bankofcanada.ca/wp-content/uploads/2010/09/dsouza-lai.pdf
Investopedia. (2014). Glass-Steagall Act. Retrieved December 7, 2014, from http://www.investopedia.com/terms/g/glass_steagall_act.asp
World Bank. (2012). Rethinking the role of the state in finance. World Bank. Retrieved December 7, 2014, from http://siteresources.worldbank.org/EXTGLOBALFINREPORT/Resources/8816096-1346865433023/8827078-1346865457422/GDF_2013_Report.pdf
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