Bank merger policy has long needed a makeover — just not this one

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Until this month, the Department of Justice hadn't finalized the adoption of new bank merger policy guidelines since 1995. Given the banking industry's rapid evolution during the last three decades, an update was certainly overdue. It unfortunately took the bank failures of 2023 to inspire action on a much-needed bank merger policy makeover, and regulators hastily charged ahead to propose sweeping reforms.

Despite soliciting feedback from industry experts and policy analysts that revealed a swath of concerns, the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency locked step with the DOJ to finalize their respective rewrites of bank merger criteria largely as proposed. This is not the bank merger makeover we needed.

Banking regulators realize that allowing high-risk banks to make still-bigger bets by swallowing other banks can pave a swift path toward a systemic crisis. But, as I emphasized in a recent study submitted to the regulators, their new policies introduce other threats to the industry's stability. (The study received funding from The PNC Financial Services Group, Inc. However, the paper represents the views of Federal Financial Analytics, Inc., which retained editorial control and takes full responsibility for all views and methodologies presented.) Bank merger applicants now face heightened uncertainty and delays that are sure to deter the pursuit of sound deals, leaving the door wide open for those making last-gasp efforts to avoid failure.

Scrupulous, modern and aggressive antitrust policy is necessary, but those who govern banks must recognize that midsize bank mergers aren't monopoly rent-seeking. They are critical if we are to prevent more regional bank failures and stop more market power from shifting to a few giant banks and tech-platform companies. The new merger policies were clearly drafted by those who know that they do not like big bank mergers. What they just as clearly do not know is what they would like instead.

If banks are to stay close to home and know their individual customers as they once did, then banks will need to make a market rate of return when they do. Banks that do not satisfy investors are banks that do not survive over the long term. To survive over the long term, midsize banks must not only compete with other banks topping $4.1 trillion in assets and giant tech platform companies offering payment services, they're also up against asset managers that increasingly dominate corporate finance — with one firm holding as much as $10.6 trillion in products that often look a lot like savings accounts.

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The only way midsize banks can hope to withstand this withering fusillade is by marshaling economies of scale and scope. This can be done in two ways: organic growth and/or mergers that add scope and scale via improved efficiencies wrought by effective operational integration — again, one of the key requirements and improvements in the banking agencies' new policies.

Is midsize bank organic growth possible? Yes, but not at anything close to the scale essential for long-term profitability and, thus, corporate survival. Just two banks — JPMorgan and Bank of America — measure their asset growth from just 2019 to the first quarter of this year by more assets than entire asset balance sheets of the three largest "superregional" banks.

Does the need for midsize bank mergers mean that all midsize bank mergers should be approved? Of course not. Last year's systemic crisis made it clear that only sound mergers that make the U.S. banking system stronger should be approved. These are mergers judged on criteria such as the ability of an acquirer to quickly and smoothly integrate the target bank into its operations, meet the convenience and needs of its communities, and have sustained profitability, robust capital and operational resilience to withstand even acute stress. It is fit and proper for the banking agencies to update their policies to take express account of these kinds of criteria. In fact, this could and should have been their policy at least since the 1990s (the last time a lot of fast-growing banks brought the banking industry to its knees). Blaming recent high-risk mergers on undue consolidation shifts the blame for last year's crisis to banks from bank supervisors where it rightly belongs.

Chasing after midsize banks has also taken the banking agencies' eyes off the real risk when banks have too much market power. If banks cannot grow large enough to muster economies of scope and scale, then they will gradually fade away. This will leave a very few, very big banks under uncertain bank supervision and a lot of very big nonbanks emphatically and intentionally outside any safety-and-soundness and most consumer-protection rules. If bank regulators want — as they should — banks to be able to reach communities with specialized products delivered through one-on-one relationships and to protect vulnerable consumers, they need to let midsize banks consolidate when midsize banks have the capital and capability to do so.