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Local market consolidation and bank productive efficiency

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  • Douglas D. Evanoff
  • Evren Ors

Abstract

The recent banking literature has evaluated the impact of mergers on the efficiency of the merging parties [e.g., Rhoades (1993), Shaffer (1993), Fixler and Zieschang (1993)]. Similarly, there has been analysis of the impact of eliminating bank entry restrictions on the average performance of banks [Jayaratne and Strahan (1998)]. The evidence suggests that acquiring banks are typically more efficient than are acquired banks, resulting in the potential for the new combined organization to be more efficient and, therefore, for the merger to be welfare enhancing. The evidence also suggests, however, that these potential gains are often not realized. This has led some to question the benefits resulting from the recent increase in bank merger activity. We take a somewhat more comprehensive and micro-oriented approach and evaluate the impact of actual and potential competition resulting from market-entry mergers and reductions in entry barriers on bank efficiency. In particular, in addition to the efficiency gains realized by the parties involved in a bank merger, economic theory argues that additional efficiency gains should result from the impact of the merger on the degree of local market competition. We therefore examine the impact of increased competition resulting from mergers and acquisitions on the productive efficiency of incumbent banks. Our findings are consistent with economic theory: as competition increases as a result of entry or the creation of a more viable local competitor, the incumbent banks respond by increasing their level of cost efficiency. We find this efficiency increase to be in addition to any efficiency gains resulting from increases in potential competition occurring with the initial elimination of certain entry barriers. Thus, consistent with economic theory, new entrants and reductions in entry barriers lead incumbent firms to increase their productive efficiency to enable them to be viable in the more competitive environment. Studies evaluating the impact of bank mergers on the efficiency of the combining parties alone may be overlooking the most significant welfare enhancing aspect of merger activity. We do not find evidence of profit efficiency gains. In fact, the mergers are associated with decreases in profit efficiency; perhaps indicating that revenues may also be competed away from incumbents as a result of mergers.

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  • Douglas D. Evanoff & Evren Ors, 2002. "Local market consolidation and bank productive efficiency," Working Paper Series WP-02-25, Federal Reserve Bank of Chicago.
  • Handle: RePEc:fip:fedhwp:wp-02-25
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    2. Pietro Alessandrini & Luca Papi & Alberto Zazzaro, 2003. "Banche, territorio e sviluppo," Moneta e Credito, Economia civile, vol. 56(221), pages 3-43.
    3. Robert DeYoung & William Hunter & Gregory Udell, 2004. "The Past, Present, and Probable Future for Community Banks," Journal of Financial Services Research, Springer;Western Finance Association, vol. 25(2), pages 85-133, April.
    4. Emilios Galariotis & Kyriaki Kosmidou & Dimitrios Kousenidis & Eirini Lazaridou & Trifon Papapanagiotou, 2021. "Measuring the effects of M&As on Eurozone bank efficiency: an innovative approach on concentration and credibility impacts," Annals of Operations Research, Springer, vol. 306(1), pages 343-368, November.
    5. Carol Ann Northcott, 2004. "Competition in Banking: A Review of the Literature," Staff Working Papers 04-24, Bank of Canada.
    6. Hughes, Joseph P. & Lang, William W. & Mester, Loretta J. & Moon, Choon-Geol & Pagano, Michael S., 2003. "Do bankers sacrifice value to build empires? Managerial incentives, industry consolidation, and financial performance," Journal of Banking & Finance, Elsevier, vol. 27(3), pages 417-447, March.
    7. César Orosco, 2007. "Random utility models of demand for the U.S. commercial banking industry," Revista de Analisis Economico – Economic Analysis Review, Universidad Alberto Hurtado/School of Economics and Business, vol. 22(2), pages 47-74, December.
    8. Ramiro Sosa Navarro, 2010. "Fiscal Imbalances, Inflation and Sovereign Default Dynamics," Ensayos de Política Económica, Departamento de Investigación Francisco Valsecchi, Facultad de Ciencias Económicas, Pontificia Universidad Católica Argentina., vol. 1(4), pages 108-142, Octubre.
    9. Tan, Yong & Anchor, John, 2017. "The impacts of risk-taking behaviour and competition on technical efficiency: Evidence from the Chinese banking industry," Research in International Business and Finance, Elsevier, vol. 41(C), pages 90-104.
    10. William Emmons & R. Gilbert & Timothy Yeager, 2004. "Reducing the Risk at Small Community Banks: Is it Size or Geographic Diversification that Matters?," Journal of Financial Services Research, Springer;Western Finance Association, vol. 25(2), pages 259-281, April.
    11. Meriem Haouat & Diego N. Moccero & Ramiro Sosa Navarro, 2012. "Foreign Banks and Credit Volatility: The Case of Latin American Countries," Review of International Economics, Wiley Blackwell, vol. 20(5), pages 1017-1033, November.
    12. Abdul Rafay & Saqib Farid, 2018. "Competitive Environment in Banking Industry: Evidence from an Emerging Economy," Business & Economic Review, Institute of Management Sciences, Peshawar, Pakistan, vol. 10(3), pages 65-84, September.
    13. Andrieş, Alin Marius & Căpraru, Bogdan, 2014. "The nexus between competition and efficiency: The European banking industries experience," International Business Review, Elsevier, vol. 23(3), pages 566-579.
    14. Pietro Alessandrini & Luca Papi & Alberto Zazzaro, 2003. "Banks, regions and development," BNL Quarterly Review, Banca Nazionale del Lavoro, vol. 56(224), pages 23-55.
    15. Otero, Luis & Razia, Alaa & Cunill, Onofre Martorell & Mulet-Forteza, Carles, 2020. "What determines efficiency in MENA banks?," Journal of Business Research, Elsevier, vol. 112(C), pages 331-341.
    16. Bayeh, Antonio & Bitar, Mohammad & Burlacu, Radu & Walker, Thomas, 2021. "Competition, securitization, and efficiency in US banks," The Quarterly Review of Economics and Finance, Elsevier, vol. 80(C), pages 553-576.
    17. Joseph P. Hughes & Loretta J. Mester, 2012. "A primer on market discipline and governance of financial institutions for those in a state of shocked disbelief," Working Papers 12-13, Federal Reserve Bank of Philadelphia.
    18. Robert DeYoung & William C. Hunter, 2001. "Deregulation, the Internet, and the competitive viability of large banks and community banks," Working Paper Series WP-01-11, Federal Reserve Bank of Chicago.
    19. Robert DeYoung, 2002. "New Bank Start-Ups: Entrepreneurs Funding Other Entrepreneurs," Journal of Entrepreneurial Finance, Pepperdine University, Graziadio School of Business and Management, vol. 7(3), pages 61-76, Fall.
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