ByRobert L. Webb
During the past 20 years, the banking industry has experienced unprecedented merger activity. From 1980 to 1998, there were almost 8,000 banking mergers, with total acquired assets of $2.4 trillion. During the 1990s, many of these mergers involved large banks. In fact, more than half of the assets acquired during the period 1980-98 were acquired during 1995-98.
Some of these proposed mergers had the potential for serious anti-competitive effects in local markets. Yet, during this period, hardly any mergers were denied on competitive grounds. The reason? Merging banks often were required to sell one or more offices in markets where they were direct competitors. This is known as divestiture.
Divestiture is one of the most important antitrust remedies at the disposal of bank regulators today. Without it, many large bank mergers would never be approved. Although competitive problems usually arise in only a few of the markets where merging banks do business, U.S. antitrust laws clearly state that just one problem market area is enough to deny an entire merger.
Regulators and bankers have discovered that divesting a small number of offices in problem markets can bring most questionable mergers into compliance with the law. Of course, for some of the largest mergers, hundreds of offices and billions of deposit dollars may have to be divested, but even these divestitures involve relatively small parts of the total merger transactions.
The purpose of divestiture is to restore the competitive balance in the market, which otherwise would have been lost by the merger. Divestiture prevents merging banks from obtaining adverse market power by keeping concentration in the local market within the limits prescribed by the U.S. Department of Justice (DOJ).
After the divestiture, the divested offices become strong competitors in the market and are able to provide a full range of banking services to local customers. At least that's the theory. But in practice, does divestiture really achieve its goals?
In a recent study on bank divestiture, Burke (1998) examines this issue. In order for divestiture to succeed, divested offices must retain their deposits and not let them revert to the original seller. Because the seller typically continues to maintain a significant presence in the market, some divested customers might be inclined (or induced) to move their accounts to the seller's remaining offices. Burke has found that divested offices initially may lose market share (although not necessarily to the seller); nonetheless, in the long term the divested offices are able to either maintain or increase their market share. This result is consistent with other research studies, which indicates that location is a primary factor for consumers and businesses when they select a bank.
Burke also examines several characteristics of divestiture transactions to see what impact they might have on the success of divested offices. He found that sellers who retain a large share of the market after divestiture were no more likely to regain customers from divested offices than the sellers who only retained smaller market shares. He also found that bank offices that are divested to larger banking organizations are more successful at increasing market share than offices that are divested to smaller banking organizations.
This supports a practice of the DOJ, which (among other things) will sometimes require that offices be divested only to large banks. The DOJ often will dictate many divestiture details to ensure that divested offices can become viable competitors. Bank regulators, on the other hand, generally feel that such interventions are unnecessary. Interestingly, Burke finds that (on average) divested offices actually perform worse in cases where the DOJ intervenes.
So, is bank divestiture effective? The evidence suggests that divestiture does achieve its goals and is an effective antitrust remedy. And it has become a key element in keeping banking markets competitive during a period of unprecedented consolidation.