Event-Study Evidence of the Value of Relaxing Longstanding Regulatory Restraints on Banks, 1970-2000

Abstract

In a partial-equilibrium model, removing a binding constraint creates value. However, in general equilibrium, the stakes of other parties in maintaining the constraint must be examined. In financial deregulation, the fear is that expanding the scope and geographic reach of very large institutions might unblock opportunities to build market power from informational advantages and size-related safety-net subsidies. This paper reviews and extends event-study evidence about the distribution of the benefits and costs of relaxing longstanding geographic and product-line restrictions on U.S. financial institutions. The evidence indicates that the new financial freedoms may have redistributed rather than created value. Event returns are positive for some sectors of the financial industry and negative for others. Perhaps surprisingly, where customer event returns have been investigated, they prove negative. Thirty years ago, opportunities for U.S. banks to expand their geographic reach and product line were tightly constrained by charter limitations and by state and federal laws governing branch banking and holding-company affiliation. The idea that, within a single generation, large U.S. banks could become nation-spanning, superpowered financial conglomerates seemed an academic pipe dream. In 1970, commercial banks could be distinguished from other kinds of financial institutions by two unique capacities: their right to offer demand deposits and their ability to make commercial loans. Restrictions on thrift, securities, insurance, and sales-finance companies made it hard for these and other kinds of nonbank institutions to offer close substitutes for banking's signature products. This paper seeks to clarify how and why technological change undermined and finally demolished geographic and product-line constraints on U.S. financial institutions and to review event-study evidence about the intersectoral distribution of the benefits and costs of relaxing particular restrictions. The evidence indicates that the demolition of these restraints intensifies public-policy concerns about the extent to which market power may be generated by large-bank mergers and safety-net subsidies that increase as an institution reaches megasize and megacomplexity.

The Benefits of Banking Mega‐Mergers: Event Study Evidence from the 1998 Failed Mega‐Merger Attempts in Canada

“…Benefits of Banking Mega-mergers Berger et al (1999), Kane (2000), and Carow and Kane (2001) identify three categories of benefits that may motivate mergers: scale and scope economies, access to safety net subsidies, and market power. These categories assume wealth-maximization as the primary motive for the merger.2…”

“…The efficiency argument is that mergers can change "input or output quantities in ways that reduce costs, increase revenues, and/or reduce risks to increase value for a given set of prices" (Berger et al, 1999, p. 157). Specific efficiencies are: economies of scale, which permit combined institutions to obtain more business or produce services at lower average costs; economies of scope, which are created when the combination of two or more separate products or services enhances revenues or costs; and X-efficiency gains, which result when the efficient banks merge and reform the practices of less efficient banks (Carow & Kane, 2001).…”

“…However, we find the first merger announcement accompanied by positive returns for partners and rivals alike, thus making it unlikely that the presumption of access to safety net guarantees explains the result. Finally, the market power argument as the major benefit for large-scale mergers is that the mergers increase concentration to the point of allowing the merged entity to raise profits by setting higher prices for banking services than is possible without the merger (Berger et al, 1999;Carow & Kane, 2001;Pennacchi, 2000), and at the extreme, to extract monopoly rents (Kane, 2000).…”

Wealth Effects of Banks' Rights to Market and Originate Annuities

“…They could gain or lose either as taxpayers, through the expansion of government deposit-insurance liabilities, or as customers, depending on whether the fusion of banking and insurance creates monopoly power. For further discussion, see Carow and Kane (2001) and references cited therein.…”

Cross‐Industry Product Diversification and Contagion in Risk and Return: The case of Bank‐Insurance and Insurance‐Bank Takeovers

“…Similarly, some studies report positive market reactions around court rulings allowing U.S. banks to sell annuities (Carow, 2001b) and in response to the Citicorp-Travelers merger (Carow, 2001a). In a survey study, Carow and Kane (2002) conclude that the relaxation of long-standing geographic/product line restrictions on the U.S. financial firms may have redistributed, rather than created, value; while Dontis-Charitos, Molyneux, and Staikouras (2011) and Fields, Fraser, and Kolari (2007a, 2007b find positive abnormal returns for bank-insurance announcements and Hagendorff, Collins, and Keasey (2008) show that banks diversifying into other financial activities create value for shareholders under weak investor protection regimes in Europe.…”