https://www.economist.com/leaders/2023/04/20/why-america-will-soon-see-a-wave-of-bank-mergers

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[                    ]
Leaders | The prize of size

Why America will soon see a wave of bank mergers

Cheap valuations and a stricter rulebook point towards more
consolidation

2EM76MR A Wells Fargo bank branch next to a branch of JP Morgan Chase
in Greenwich Village in New York on Tuesday, January 1, 2019. (Photo
by Richard B. Levine)
Apr 20th 2023
Share

The trouble facing many of America's banks is coming into sharp
relief. After the failures of Silicon Valley Bank (SVB) and Signature
Bank in March, behemoths such as JPMorgan Chase and Bank of America
attracted deposits despite paying minimal interest, according to
earnings reports released since April 14th. Many small and
medium-sized banks, by contrast, face increasing competition for
customers and rising funding costs. On April 18th Western Alliance, a
lender with $71bn of assets, reported that it had lost 11% of its
deposits this year. To tempt deposits back, banks will have to pay
more for them; in the meantime many have turned to temporary loans,
including from the Federal Reserve, that incur today's high rates of
interest. Yet lots of banks' assets are low-yielding and cannot be
sold without crystallising losses. A big profits squeeze is coming.

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More banks were due to report earnings after we published this
leader. But the market has already made a judgment: America's banks
are worth only about their combined book value, having traded at
nearly a 40% premium at the start of the year. The likely result of
their low valuations, combined with a landscape in which size
matters, is a tried-and-tested response to banking crises over the
past four decades: consolidation.

[20230422_L]

America has 4,700 banks and savings institutions, or one for every
71,000 residents. To observers in the eu, which has only one bank for
every 85,000 people, that seems excessive. Yet it is a historical
low: in 1984, when comparable data begin and the population was much
smaller, there were nearly four times as many institutions. Since
then the industry has seen almost continuous consolidation. The
biggest wave of mergers came after a long-running crisis among
savings and loan associations (S&Ls), lenders specialising in
mortgages, reached its apex in the late 1980s. It left many carcasses
over which stronger banks could pick. Rule changes, such as the
lifting of restrictions on banking across state lines, also
encouraged banks to grow in size.

There are several parallels between then and now. Many S&Ls went bust
because their funding costs rose as interest rates surged, while
their mortgage-loan books brought in low, fixed rates of interest. At
one point nearly two-thirds of S&Ls would have been insolvent had
their assets been marked to market. Although the balance-sheet
problems of today's banks are less severe, they are similar in
nature. At the end of 2022 more than 400 banks with nearly $4trn in
combined assets had unrealised losses on their securities portfolios
worth at least half of their core equity capital. Include their
fixed-rate loan books, and possible losses to come on lending against
commercial property, and the hole would be greater still.

At the same time, smaller banks are at risk of losing the regulatory
advantages they now enjoy. When calculating their regulatory capital,
banks with less than $700bn in assets typically do not have to mark
to market even the securities that they class as "available for sale"
and which are meant to be a source of quick cash in an emergency.
Those smaller than $250bn are exempted from the strictest liquidity
rules, stress tests and failure planning. This light-touch regulatory
regime is now being reviewed by domestic and international
regulators. The Basel Committee on Banking Supervision, which writes
the global rulebook, is studying the lessons to be learned from the
failure of SVB, whose depositors were bailed out even though it was
too small and domestically focused to be subject to the strictest
rules. In Washington, an easing of the rules for midsized banks by
Congress and the Fed in 2018 and 2019 is under fresh scrutiny.

The most important changes to the market's structure are likely to be
among banks which are close to significant regulatory thresholds.
There are 20 banks which are between $100bn and $250bn in size. If
the penalty for crossing the $250bn threshold is reduced, many may
find it advantageous to merge. Doing so would allow them to spread
the growing costs of complying with regulation over a bigger
business, while making it even more likely that their depositors
would be bailed out in a crisis. Regulators would probably look
favourably on tie-ups that swallowed up zombie banks which might
otherwise "gamble for resurrection" by taking big risks--a tactic that
made the S&L crisis in the 1980s much worse. If so, then the latest
crisis will provide the latest impetus for banks to get bigger. #

This article appeared in the Leaders section of the print edition
under the headline "The prize of size"

Leaders April 22nd 2023

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    Europe's
  * Bolivia's crisis shows the limits of left-wing populism
  * In Sudan and beyond, the trend towards global peace has been
    reversed
  * Why America will soon see a wave of bank mergers
  * Why the world should welcome competition from Chinese carmakers

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From the April 22nd 2023 edition

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