This article designs a framework for evaluating the causes, consequences, and future implications of financial services industry consolidation, reviews the extant research literature within the context of this framework (over 250 references), and suggests fruitful avenues for future research. The evidence is consistent with increases in market power from some types of consolidation; improvements in profit eAciency and diversification of risks, but little or no cost eAciency improvement on average; relatively little eAect on the availability of services to small customers; potential improvements in payments system eAciency; and potential costs on the financial system from increases in systemic risk or expansion of the financial safety net. ” 1999 Elsevier Science B.V. All rights reserved.

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The consolidation of the financial services industry: Causes, consequences, and implications for the future

This study reviews the performance of banks in twelve countries or territories in Europe, North America and Australia and examines the internal and external determination of profitability. To circumvent some of the difficulties in making comparisons between banks in different countries, the concept of ‘value added’ is introduced. Results parallel those in domestic U.S. studies and provide some support for the Edwards-Heggestad-Mingo hypothesis of risk avoidance by banks with a high degree of market power.

Concentration and other determinants of bank profitability in Europe, North America and Australia

Potential diversification benefits are one reason why US financial holding companies are offering a growing range of financial services. This paper examines whether the observed shift toward activities that generate fees, trading revenue, and other non-interest income has improved the performance of US financial holding companies (FHCs) from 1997 to 2002. We find evidence that diversification benefits exist between FHCs, but these gains are offset by the increased exposure to non-interest activities, which are much more volatile but not necessarily more profitable than interest-generating activities. Within FHCs, however, marginal increases in revenue diversification are not associated with better performance, while marginal increases in non-interest income are still associated with lower risk-adjusted profits. The key finding that diversification gains are more than offset by the costs of increased exposure to volatile activities represents the dark side of the search for diversification benefits and has implications for supervisors, managers, investors, and borrowers.

The dark side of diversification: The case of US financial holding companies

Bankruptcy prediction in banks and firms via statistical and intelligent techniques – A review

Most commercial loans are made on a secured basis, yet little is known about the relationship between collateral and credit risk. Several theoretical studies find that when borrowers have private information about risk, the lowest-risk borrowers tend to pledge collateral. In contrast, conventional wisdom holds that when risk is observable, the highest-risk borrowers tend to pledge collateral. An additional issue is whether secured loans (as opposed to secured borrowers) tend to be safer or riskier than unsecured loans. Empirical evidence presented here strongly suggests that collateral is most often associated with riskier borrowers, riskier loans and riskier banks.

Collateral, loan quality, and bank risk

The creation of a number of very large and sometimes increasingly complex financial institutions, resulting in part from the on-going consolidation of the financial system, has raised concerns that the degree of systemic risk in the financial system may have increased. We argue that firm inter-dependencies, as measured by correlations of stock returns, provide an indicator of systemic risk potential. We analyze the dynamics of the stock return correlations of a sample of US large and complex banking organizations (LCBOs) over 1988–1999, and find a significant positive trend in stock return correlations. This finding is consistent with the view that the systemic risk potential in the financial sector appears to have increased over the last decade. In addition, we relate firms' return correlations to their consolidation activity by estimating measures of the consolidation elasticity of correlation. Consolidation at the sample LCBOs appears to have contributed to LCBOs inter-dependencies. However, consolidation elasticities of correlation exhibit substantial time variation, and likely declined in the latter part of the decade. Thus, factors other than consolidation have also been responsible for the upward trend in return correlations.

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Systemic risk and financial consolidation: Are they related?

In antitrust analysis of bank mergers, banking markets are viewed as geographically local, with a "cluster" of products as the relevant product line. This view is criticized as outdated, now that many bank products are offered by non-bank institutions, and financial institutions' operations are increasingly national in scope. This paper reexamines the question of market definition in banking, using two micro data sets uniquely well suited to the task. We find that local depositories remain the dominant supplier of key financial services to households and small businesses, with geographic proximity still important in their institution choice.

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Market Definition and the Analysis of Antitrust in Banking

This study uses portfolio theory to investigate empirically the potential for diversification gains from expanded bank securities powers. Diversification potential is examined using microeconomic data on returns to existing bank securities and non-securities activities over 1976 through 1985. Both the mean and standard deviation of returns to securities activities are found to be greater than those of non-securities activities. Some potential for diversification gains is found, although this appears to be quite limited. Experiments designed to estimate the effect of using industry and time aggregated data are performed.

The impact of underwriting and dealing on bank returns and risks

Although accurate bond prices are difficult to come by, many have advocated that bank supervisors use subordinated debt spreads in the surveillance of large banking organizations. Our findings indicate that subordinated debt spreads are most consistent across data sources for the most liquid bonds (i.e., those of relatively large issuance size, relatively young age, issued by relatively large firms) traded in a relatively robust overall bond market. We also find a high degree of concordance in rankings of firms by their minimum spreads across bonds with especially strong agreement about which large firms are in the tails of the spread distribution at each point in time. Our time-series results further support and provide additional guidance for the use of subordinated debt spreads in supervisory monitoring, support the need for careful judgment when interpreting such spreads, highlight difficulties with currently available data sources, and motivate the need for further research.

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Using Subordinated Debt to Monitor Bank Holding Companies: Is it Feasible?

This study uses the 1995 Survey of Consumer Finances to examine households' use of technologies, including electronic means, to transact at a financial institution and to gain information for making saving and borrowing decisions. Household use of various technologies is correlated with household income, financial assets, age, and years of education. Results suggest that relatively new electronic technologies are used by relatively few households, and that household use of electronic sources of information for financial decision making is barely off the ground.

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Myron L. Kwast

Papers

Systemic risk and financial consolidation: Are they related?

Market Definition and the Analysis of Antitrust in Banking

The impact of underwriting and dealing on bank returns and risks

Using Subordinated Debt to Monitor Bank Holding Companies: Is it Feasible?

Who Uses Electronic Banking? Results from the 1995 Survey of Consumer Finances