When bank consolidation reaches excessive levels, it can hamper innovation.

That’s according to new research out of North Dakota State University, which examined how bank mergers and acquisitions in the U.S. affects innovation. Analyzing bank consolidation from 1994 to 2020, researchers assessed how it affects the quantity of innovation, measured by patents, and how it influences types of innovation. 

Patenting tended to increase when there are moderate levels of bank consolidation, according to the research. “Moderate,” in that case, means markets have several meaningful competitors, even if a few banks are relatively large.

But researchers noted a drop in more radical forms of innovation when consolidation became excessive, according to Oudom Hean, assistant professor of finance at NDSU. That’s when markets are dominated by only a handful of very large institutions, Hean said. 

“Banking consolidation is good for incremental innovation, but it is terrible for technological breakthroughs,” said Hean, who led the research, which was published this month. 

Still, “there’s a lot of nuance to it,” Hean said in a recent interview.

Researchers estimated the average effect of bank consolidation across locations and time periods, with the impact differing across regions depending on local economic conditions, alternative financing sources or the structure of the banking market, Hean noted.

Bank consolidation can be beneficial if banks becoming larger through acquisition are able to lend more to business customers, or economies of scale allow them to pass savings on to customers, Hean said.  

But consolidation may also alter banks’ risk tolerances, making them more inclined to extend loans to bigger, established companies than smaller, riskier borrowers, Hean said. If a few large banks control a market, lending activity tends to favor more familiar and less disruptive ideas.   

Community banks serving as the only local lender tend to have long-term relationships with business owners, and might be more willing to lend to an entrepreneur or small business even if it’s riskier, Hean said. When banking becomes highly concentrated, it could lead to a decline in business loans. 

Ultimately, bank consolidation “might be good for established firms, but it’s terrible for startups,” which are usually the types of firms pursuing technological breakthroughs or disruptive innovations, Hean said.  

With Trump-appointed regulators taking a more favorable view of bank M&A, the probability of bank deals gaining regulatory approval has increased materially, while the time to secure approval has dropped. That has led a number of banks to either strike deals or express interest in pursuing acquisitions. 

When considering mergers and acquisitions, regulators assess how the combination might affect customers’ access to banking services. But Hean said it’s also important to consider loan accessibility from an innovation perspective, because it’s a crucial component of the U.S. economy. 

It “also should be about who has access to the loans. Is it local entrepreneurs, is it a small startup or just big, established firms like Amazon, for example?” Hean said.

Additionally, private credit or venture capital options “tend to be available for places like Silicon Valley,” but “they might not be available for places like North Dakota,” Hean said. 

Hean said the findings are likely not reason enough for regulators to pump the brakes on M&A approvals, or reject a specific deal, since consolidation can be vital for banks on the brink of survival or seeking economies of scale. 

If bank consolidation could affect entrepreneurship and local businesses, states might consider pursuing novel ways to support small businesses, Hean said. That could include setting up a fund designed to benefit economic growth in the state, as North Dakota has, he said.