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Geographic Diversification: Domestic Chapter 22

Financial Institutions Management, 3/e

By Anthony Saunders

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Domestic Expansions

Historically FIs' ability to expand constrained by regulation.

Regulations also create potential opportunities for new entrants to exploit existing monopoly rents.

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Regulatory Factors Impacting Geographic Expansion

Insurance companies• State regulated.• Usually easy to establish subsidiaries

Thrifts• Since 1980s, restrictions on expanding across

state lines have been loosened considerably.

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Constraints on Domestic Expansion

Commercial Banks• Restrictions on intrastate banking have been

liberalized in a piecemeal fashion.• Interstate restrictions:

» McFadden Act, 1927

» From 1927 to 1997 relied on establishing subsidiaries rather than branching.

» Multibank holding companies (MBHC)

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Stages in Regulation of BHCs

One-bank holding company loophole in Douglas Amendment 1956.• Growth in one-bank holding companies from

1956 to 1970. 1970 Bank Holding Company Act

Amendments.• Permissible activities “closely related to

banking”

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Erosion of Interstate Banking Restrictions

Regional and national banking pacts• Nationwide• Nationwide reciprocal• Regional reciprocal

Purchase of troubled banks Nonbank banks

• Ended by Competitive Equality Banking Act, 1987

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Erosion (continued)

Expansion in OBHC activities. Riegle-Neal Interstate Banking and

Branching Efficiency Act of 1994• U.S. and nondomestic banks allowed to branch

interstate.

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Synergies from Geographic Expansion

Cost synergies• X-efficiency• Less evidence of cost savings from economies

of scale and scope Revenue synergies

• Enhance revenues by expanding into growing market or less than fully competitive market

• More stable revenue stream

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Monopoly Power Concerns

Regulators concerned with merger activity that could result in monopoly power.

Concentration ratios such as Herfindahl-Herschman Index (HHI) employed to measure the effects of merger.• HHI = sum of squared percentage market

shares.

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Other Factors Impacting Geographic Expansion

Attractiveness of bank merger measured in terms of merger premium.• Analysis indicates that highest merger

premiums paid for well-managed banks in relatively uncompetitive environments.

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Success of Geographic Expansion

Investor reaction• Abnormal returns for both acquiring bank and

target bank. Postmerger performance

• merged banks tended to outperform industry• improved ability to attract loans and deposits,

increase employee productivity and enhance asset growth.