Bank mergers ; Consolidation and merger of corporations

Frank A. Schmid

Judith H. Hazen

English

Research Papers in Economics

May 2001
MonetaryTrends
Views expressed do not necessarily reflect official positions of the Federal Reserve System.
Implications of Financial
Sector Consolidation
In a recent report, the Group of Ten (G10) assesses
possible effects of financial sector consolidation on finan-
cial risk, monetary policy, market structure and the pay-
ment system.
1 The financial sector, as defined in the
report, comprises commercial banking, investment bank-
ing, insurance and, in part, asset management.  The report
covers the eleven G10 nations, Australia and Spain.
The report was commissioned in September 1999 by
the central bank governors and finance ministers of the
G10 countries in response to a decade of high and accel-
erating levels of merger and acquisition (M&A) activity.
The strong M&A activity has created a number of large
and complex financial services providers—many with
multinational operations.
The report views efficiency gains from large-scale
operations as the driving force for consolidation in the
financial sector.  Improvements in information technology
have allowed for economies of scale in providing ser-
vices.  Financial deregulation, along with integration of
financial markets, has extended the business opportunities
for large entities.  The impetus for moving to large-scale
operations has been reinforced by increased shareholder
pressure for more efficient use of capital.
In terms of financial risk, the report notes that larger
entities are not necessarily more diversified or less risky
than their smaller counterparts.  The post-merger portfo-
lio of a financial firm might differ from the sum of the
respective pre-merger portfolios as the merger changes
market conditions and offers new business opportunities.
The report points out that financial “workouts” might be
harder to bring about for large distressed institutions than
for small ones.
The report also investigates three possible means
through which financial sector consolidation could impair
the functioning of monetary policy.  First, consolidation
might affect how monetary policy is implemented.  In
conducting open market operations, the central bank inter-
acts directly with private sector financial institutions.  If
market structure changes—for instance through a decrease
in the number of market participants—the central bank
might have to make institutional changes to these opera-
tions.  Isolated cases of such changes have been reported.
Second, consolidation might affect the way monetary
policy is transmitted to the real sector.  For instance, in the
“monetary channel,” interest rate changes are relayed
through financial markets via arbitrage.  Larger, more inte-
grated financial institutions might accelerate this process
through internal capital markets.  On the other hand, less
competition among financial institutions might slow down
transmission as price changes are passed on in the market
to a lesser degree or less rapidly.  Similarly, in the “credit
channel,” changes in monetary policy are transmitted to the
real sector through bank lending.  Again, increased concen-
tration might weaken competition and lead to incomplete or
slower delivery of liquidity supplied by the central bank.
As the report points out, so far, there is little evidence that
the monetary transmission mechanism has been impaired
through consolidation in the financial sector.
Third, when in distress, large and complex financial
institutions pose risk to the financial system.  By becoming
too big to fail, institutions shift risk to the lender of last
resort.  The central bank, which in some G10 countries
supervises banks and serves as the lender of last resort,
should bear in mind the moral hazard implied in this
activity.  The central banks should also consider carefully
the consequences of providing emergency liquidity for
the stance of monetary policy.
While it is impossible to predict future scenarios, it
seems likely that the strong M&A activity in the financial
industry will persist.  The potential effects of consolida-
tion on financial risk and monetary policy outlined in the
report should be monitored as consolidation continues.
—Judith H. Hazen
—Frank A. Schmid
1Group of Ten, Report on Consolidation in the Financial Sector, 
January 2001, http://www.bis.org.

Implications of financial sector consolidation

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Implications of financial sector consolidation

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