The dollars and sense of bank consolidation

For nearly two decades banks in the United States have consolidated in record numbers--in terms of both frequency and the size of the merging institutions. Rhoades (1996) hypothesizes that the main motivators were increased potential for geographic expansion created by changes in state laws regulating branching and a more favorable antitrust climate. To look for evidence of economic incentives to exploit these improved opportunities for consolidation, the authors examine how consolidation affects expected profit, the riskiness of profit, profit efficiency, market value, market-value efficiencies, and the risk of insolvency. Their estimates of expected profit, profit risk, and profit efficiency are based on a structural model of leveraged portfolio production that was estimated for a sample of highest-level U.S. bank holding companies in Hughes, Lang, Mester, and Moon (1996). Here, the authors also estimate two additional measures that gauge efficiency in terms of the market values of assets and of equity. Their findings suggest that the economic benefits of consolidation are strongest for those banks engaged in interstate expansion and, in particular, interstate expansion that diversifies banks' macroeconomic risk. Not only do these banks experience clear gains in their financial performance, but society also benefits from the enhanced bank safety that follows from this type of consolidation.Bank mergers

The critical O(NN) σ\sigma-model at dimension 2<d<42<d<4: Hardy-Ramanujan distribution of quasi-primary fields and a collective fusion approach

The distribution of quasiprimary fields of fixed classes characterized by their O$(N)$ representations $Y$ and the number $p$ of vector fields from which they are composed at $N=\infty$ in dependence on their normal dimension $[\delta]$ is shown to obey a Hardy-Ramanujan law at leading order in a $\frac{1}{N}$-expansion. We develop a method of collective fusion of the fundamental fields which yields arbitrary \qps and resolves any degeneracy.Comment: KL-TH-94/2, 21 pages (uuencoded Postscript file

Measuring the efficiency of capital allocation in commercial banking

Commercial banks leverage their equity capital with demandable debt that participates in the economy's payments system. The distinctive nature of this debt generates an unusual degree of liquidity risk that can, at times, threaten the payments system. To reduce this threat, insurance protects deposits; and to reduce the moral hazard problems of the debt contract and deposit insurance, bank regulation constrains risk-taking and defines standards of capital adequacy. The inherent liquidity risk of demandable debt as well as potential regulatory penalties for poor financial performance creates the potential for costly episodes of financial distress that affects banks' employment of capital. ; The existence of financial-distress costs implies that many banks are likely to take actions, such as holding additional capital, that increase bank safety at the expense of short-run returns. While such a strategy may reduce average returns in the short run, it may maximize the market value of the bank by protecting charter value and protecting against regulatory interventions. On the other hand, some banks whose charter values are low may have an incentive to follow a higher risk strategy, one that increases average return at the expense of greater risk of financial distress and regulatory intervention. ; This paper examines how banks' employment of capital in their production plans affects their "market value" efficiency. The authors develop a market-based measure of production efficiency and implement it on a sample of publicly traded bank holding companies. Our evidence indicates that banks' efficiency and, hence, the market value of their assets are influenced by the level and allocation of capital. However, even controlling for the effect of size, we find that the influence of equity capital differs markedly between banks with higher capital-to-assets ratios and those with lower ratios. For inefficient banks with higher capital-to-assets ratios, marginal increases in capitalization and asset quality boost their market-value efficiency. For inefficient banks with lower levels of capitalization, the signs of these effects are reversed. Controlling for asset size, it appears that less capitalized banks cannot afford to mimic the investment strategy of more capitalized banks, which may be using this greater capitalization to signal their safety to financial markets.Bank capital

Efficient banking under interstate branching

Nationally chartered banks will be allowed to branch across state lines beginning June 1, 1997. Whether they will depends on their assessment of the profitability of such a delivery system for their services and on their preferences regarding risk and return. The authors investigate the probable effect of interstate branching on banks' risk-return tradeoff, accounting for the endogeneity of deposit volatility. If interstate branching improves the risk-return tradeoff banks face, banks that branch across state lines may choose a higher level of risk in return for higher profits. The authors find distinct efficiency gains due to geographic diversity.Branch banks ; Interstate banking

Safety in numbers? Geographic diversification and bank insolvency risk

The Riegle-Neal Interstate Banking and Branching Efficiency Act, passed in September 1994 and effective June 1, 1997, will allow nationally chartered banks to branch across state lines. This act will remove impediments to interstate expansion and permit the consolidation of existing interstate networks ; What will be the impact of this legislation on bank performance and bank safety? Removing impediments to geographic expansion should improve the risk-return tradeoff faced by most banks. However, this paper argues that economic theory does not tell us whether an improvement in the risk-return tradeoff will lead to a reduction in the volatility of bank returns or in the probability of insolvency. ; The authors investigate the role of geographic diversification on bank performance and safety using bank holding company data. The authors find that an increase in the number of branches lowers insolvency risk and increases efficiency for inefficient bank holding companies; an increase in the number of states in which a bank holding company operates increases insolvency risk but has an insignificant effect on efficiency. Branch expansion raises the risk of insolvency for efficient bank holding companies, while an increase in the number of states has an insignfiicant effect on insolvency riskBank failures ; Interstate banking

Recovering risky technologies using the almost ideal demand system: an application to U.S. banking

Using modern duality theory to recover technologies from data can be complicated by the risk characteristics of production. In many industries, risk influences cost and revenue and can create the potential for costly episodes of financial distress. When risk is an important consideration in production, the standard cost and profit functions may not adequately describe the firm's technology and choice of production plan. In general, standard models fail to account for risk and its endogeneity. The authors distinguish between exogenous risk, which varies over the firm's choice sets, and endogenous risk, which is chosen by the firm in conjunction with its production decision. They show that, when risk matters in production decisions, it is important to account for risk's endogeneity. ; For example, better risk diversification that results, for example, from an increase in scale, improves the reward to risk-taking and may under certain conditions induce the firm to take on more risk to increase the firm's value. A choice of higher risk at a larger scale could add to costs and mask scale economies that may result from better diversification. ; This paper introduces risk into the dual model of production by constructing a utility-maximizing model in which managers choose their most preferred production plan. The authors show that the utility function that ranks production plans is equivalent to a ranking of subjective probability distributions of profit that are conditional on the production plan. The most preferred production plan results from the firm's choice of an optimal profit distribution. The model is sufficiently general to incorporate risk aversion as well as risk neutrality. Hence, it can account for the case where the potential for costly financial distress makes trading profit for reduced risk a value-maximizing strategy. ; The authors implement the model using the Almost Ideal Demand System to derive utility-maximizing share equations for profit and inputs, given the output vector and given sources of risk to control for choices that would affect endogenous risk. The most preferred cost function is obtained from the profit share equation and we show that, if risk neutrality is imposed, this system is identical to the standard translog cost system except that it controls for sources of risk. ; The authors apply the model to the U.S. banking industry using 1989-90 data on banks with over $1 billion in assets. The authors find evidence that managers trade return for reduced risk, which is consistent with the significant regulatory and financial costs of bank distress. In addition, the authors find evidence of significant scale economies that help explain the recent wave of large bank mergers. Using these same data, the authors also estimate the standard cost function, which does not explicitly account for risk, and they obtain the usual results of esentially constant returns to scale, which contradicts the often-stated rationale for bank mergers.Banks and banking ; Economies of scale

Recovering risky technologies using the almost ideal demand system: an application to U.S. banking

The authors argue for a shift in the focus of modeling production from the traditional assumptions of profit maximization and cost minimization to a more general assumption of managerial utility maximization that can incorporate risk incentives into the analysis of production and recover value-maximizing technologies. The authors show how this shift can be implemented using the Almost Ideal Demand System. In addition, the authors suggest a more general way of measuring efficiency that can incorporate a concern for the market value of firms' assets and equity and identify value-maximizing firms. This shift in focus bridges the gap between the risk-incentives literature in banking that ignores the microeconomics of production and the production literature that ignores the relationship between production decisions and risk.Banks and banking - Costs ; Banks and banking

Pairing and superconductivity driven by strong quasiparticle renormalization in two-dimensional organic charge transfer salts

We introduce and analyze a variational wave function for quasi two-dimensional kappa-ET organic salts containing strong local and nonlocal correlation effects. We find an unconventional superconducting ground state for intermediate charge carrier interaction, sandwiched between a conventional metal at weak coupling and a spin liquid at larger coupling. Most remarkably, the excitation spectrum is dramatically renormalized and is found to be the driving force for the formation of the unusual superconducting state.Comment: 4 pages, 4 figure