the editor (Allen Berger), and two anonymous referees for their suggestions and comments. Roberto Felici provided outstanding research assistance. The opinions expressed do not necessarily reflect those of the Bank of Italy. DARIO FOCARELLI FABIO PANETTA CARMELO SALLEOWhy Do Banks Merge?The banking industry is consolidating at an accelerating pace, yet no conclusive results have emerged on the benefits of mergers and acquisitions. In order to investigate the motives and results of each type of deal we consider separately acquisitions (that is, the purchase of the majority of voting shares) and mergers, using Italian data. Mergers seek to improve income from services, but the increase is offset by higher staff costs; return on equity improves because of a decrease in capital. Acquisitions aim to restructure the loan portfolio of the acquired bank; improved lending policies result in higher profits. THE FINANCIAL INDUSTRY is consolidating at an accelerating pace: the integration of financial markets has blurred distinctions between activities such as lending, investment banking, asset management, and insurance. Firms have reacted to the sharper competition by cutting costs and expanding in size, often by merging with competitors or taking them over. Long isolated by protective regulations, banks are among the most active players. Technological innovations and a thorough-going deregulation have prompted a wave of mergers in the banking industry throughout the world, starting in the United States in the eighties and reaching Europe in the nineties.

In response to fundamental changes in regulation and technology, the financial industry around the world is undergoing an unprecedented wave of consolidation. A growing body of empirical literature has attempted to measure the efficiency gains from M&As; however there is little sense of how the results might depend on the country, industry and time period analysed. In this paper we review critically works that cover the main sectors of the financial industry (commercial and investment banks, insurance and asset management companies) in the major industrialised countries over the last twenty years, searching for common patterns that transcend national and sectoral peculiarities. We find that consolidation in the financial sector is beneficial up to a relatively small size in order to reap economies of scale, but there is little evidence that mergers yield economies of scope or gains in managerial efficiency.

We analyze the main forces affecting financial system pro-cyclicality (the fact that developments in the financial sector can amplify business cycle fluctuations). We first review some major structural developments in financial markets that may influence pro-cyclicality and that have been overlooked in earlier analyses. We then examine three issues that are center stage in the current debate: capital regulation, accounting standards and managers' incentives. After reviewing the institutional set-up and the key mechanisms at work, we critically examine a series of proposals designed to mitigate pro-cyclicality.1 All authors are with the Banca d'Italia.

In response to fundamental changes in regulation and technology, the financial industry around the world is undergoing an unprecedented wave of consolidation. A growing body of empirical literature has attempted to measure the efficiency gains from M&As; however there is little sense of how the results might depend on the country, industry and time period analysed. In this paper we review critically works that cover the main sectors of the financial industry (commercial and investment banks, insurance and asset management companies) in the major industrialised countries over the last twenty years, searching for common patterns that transcend national and sectoral peculiarities. We find that consolidation in the financial sector is beneficial up to a relatively small size in order to reap economies of scale, but there is little evidence that mergers yield economies of scope or gains in managerial efficiency.

In response to fundamental changes in regulation and technology, the financial industry around the world is undergoing an unprecedented wave of consolidation. A growing body of empirical literature has attempted to measure the efficiency gains from M&As; however there is little sense of how the results might depend on the country, industry and time period analysed. In this paper we review critically works that cover the main sectors of the financial industry (commercial and investment banks, insurance and asset management companies) in the major industrialised countries over the last twenty years, searching for common patterns that transcend national and sectoral peculiarities. We find that consolidation in the financial sector is beneficial up to a relatively small size in order to reap economies of scale, but there is little evidence that mergers yield economies of scope or gains in managerial efficiency.