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The importance of scale economies and geographic diversification in community bank mergers

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  • William R. Emmons
  • R. Alton Gilbert
  • Timothy J. Yeager

Abstract

Mergers of community banks across economic market areas potentially reduce both idiosyncratic and local market risk. A merger may reduce idiosyncratic risk because the larger post-merger bank has a larger customer base. Negative credit and liquidity shocks from individual customers would have smaller effects on the portfolio of the merged entity than on the individual community banks involved in the merger. Geographic dispersion of banking activities across economic market areas may reduce local market risk because an adverse economic development that is unique to one market area will not affect a bank's loans to customers located in another market area. ; This paper simulates the mergers of community banks both within and across economic market areas by combining their call report data. We find that idiosyncratic risk reduction dominates local market risk reduction. In other words, a typical community bank can diversify away its idiosyncratic risk almost as completely by merging with a bank across the street as it can by merging with one located across the country. The bulk of the pure portfolio diversification effects for community banks, therefore, appear to be unrelated to diversification across market areas but, instead, are related to bank size. These findings help explain why many community banks have not pursued geographic diversification more aggressively, but they beg the question as to why more small community banks do not pursue in-market mergers.

Suggested Citation

  • William R. Emmons & R. Alton Gilbert & Timothy J. Yeager, 2001. "The importance of scale economies and geographic diversification in community bank mergers," Working Papers 2001-024, Federal Reserve Bank of St. Louis.
  • Handle: RePEc:fip:fedlwp:2001-024
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    References listed on IDEAS

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    Cited by:

    1. Manuel Illueca & José Pastor & Emili Tortosa-Ausina, 2009. "The effects of geographic expansion on the productivity of Spanish savings banks," Journal of Productivity Analysis, Springer, vol. 32(2), pages 119-143, October.
    2. Berger, Allen N. & DeYoung, Robert, 2006. "Technological Progress and the Geographic Expansion of the Banking Industry," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(6), pages 1483-1513, September.
    3. Timothy J. Yeager, 2002. "The demise of community banks? local economic shocks aren't to blame," Supervisory Policy Analysis Working Papers 2002-03, Federal Reserve Bank of St. Louis.
    4. Timothy J. Yeager, 2002. "Community bank performance in the presence of county economic shocks," Supervisory Policy Analysis Working Papers 2002-11, Federal Reserve Bank of St. Louis.

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    Keywords

    Bank supervision ; Bank mergers;

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