Digital banks, credit unions and nonbanks should be factored into a revamped measure of market competition when considering a bank merger, Federal Reserve Gov. Michelle Bowman told a gathering held Wednesday by the Conference of State Bank Supervisors (CSBS).
The framework for evaluating mergers “is meant to promote a competitive marketplace for banking products and services,” Bowman said Wednesday. “But if that framework does not account for the full range of competitors, we're only restricting banks from making strategic merger choices, while allowing those outside the framework to proliferate.”
A July 2021 executive order from President Joe Biden demanding “more robust scrutiny” of bank mergers by the Fed and other agencies gives regulators a “unique opportunity” to tweak the parameters of what constitutes adverse competition — a notion that hasn’t seen a significant update since 1995, Bowman said Wednesday.
Guidelines from that era use the Herfindahl-Hirschman index (HHI) — a figure that increases as branches consolidate and markets concentrate — to gauge a financial institution’s deposit market share.
But risk analysis, not size, should steer the review of a merger application, Bowman asserted Wednesday.
Under 1995 screening criteria, proposed mergers that produce an HHI score of less than 1,800 for a banking market on a scale to 10,000, or increase the HHI by less than 200, likely won’t trigger in-depth review, Bowman said. But more than 60% of geographic banking markets in the U.S., as they’re defined now, surpass the 1,800 threshold, she said.
Using deposit share as a proxy for market power may have worked before the proliferation of the internet because banks are required to report branch deposits annually through a survey by the Federal Deposit Insurance Corp. (FDIC), Bowman noted.
But while deposits at brick-and-mortar branches grew by roughly 21% from 2019 to 2020, online deposits increased at nearly three times that rate, Bowman said.
“Since we know that deposit relationships generally lead customers to develop other types of banking relationships, a comprehensive analysis of competition needs to account for the ubiquity of out-of-market banks with a strong national presence,” Bowman said. “In the absence of specific data about a digital bank's presence in a market, [online] deposits should be weighed in pro rata in each banking market at the percentage reported annually in the summary of deposits in any competitive analysis.”
Analysts “have to get creative” when measuring the competitive effect of nonbanks because they generally don’t have the same reporting requirements as banks, Bowman said.
To solve that, Bowman recommended relaxing the HHI thresholds in bank merger guidelines to reflect the influx of nonbank competition.
Looser restrictions also may benefit struggling rural community banks that may be forced to seek a merger with an out-of-market partner because combining with another local community bank would drive up HHI, Bowman said.
The Fed should also review how it defines banking markets to ensure they are updated consistently and reflect change, she added.
Credit unions, too, represent a burgeoning source of competition because many — since 1995, when they were left off competitive screening — have adopted geography-based membership criteria and now offer business loans, Bowman said. She pointed also to an uptick, in recent years, of bank acquisitions by credit unions.
“Credit unions whose field of membership includes all, or almost all, of the market populations, whose branches are easily accessible to the public, who engage in a significant amount of commercial lending and who have staff available for small business services, or who have acquired a community bank should be part of any initial competitive screen,” Bowman said.
Bowman urged the National Credit Union Administration (NCUA) to collect “more granular deposit information” from credit unions to give a clearer picture of their local market power.
“Similar activity should be subject to similar data collection and regulation,” she said.