Fed is a rubber stamp for bank mergers — it’s a problem

In a few weeks, the Federal Reserve will convene the first of two public meetings on BB&T’s proposal to merge with SunTrust. If approved by regulators, this combination would create the sixth-largest bank in the U.S. — by far the biggest bank merger since the financial crisis.

The Fed’s decision to hold public meetings on the BB&T-SunTrust deal is a welcome development, signaling that perhaps the Fed will fulfill its responsibility to rigorously review the merger’s potential risks.

The Fed’s recent track record on bank mergers, however, is not encouraging.

Historically, the Fed has approved the vast majority of bank merger proposals. But the Fed set a record in 2018. According to data published last month, the Fed approved 95% of bank merger applications last year — its highest approval rate since it began keeping track in 2011.

Not only is the Fed greenlighting nearly all merger proposals, but it is signing off on them with record speed. In the past, the Fed has taken nearly a full year, on average, to review bank mergers that attract adverse public comments. In 2018, it approved such applications in an average of four months.

The Fed’s rubber-stamping of bank mergers is worrisome. Unrestrained bank consolidation hurts consumers and could imperil the financial system.

Bank mergers lower the availability and increase the cost of credit for borrowers, especially small businesses and farmers. Meanwhile, consolidation among regional and super-regional banks elevates risks to financial stability. Indeed, according to the Fed’s own data, the collapse of a merged BB&T-SunTrust would be far worse for the economy than if both banks failed separately.

That’s not to say that bank consolidation is always bad. Some bank mergers — particularly among community banks — can increase efficiencies without harming consumers or endangering financial stability.

But the Fed has neglected its responsibility to scrutinize bank merger proposals in two critical ways.

The Fed’s first problem is procedural. By rule, the Federal Reserve must evaluate merger proposals transparently, allowing the public an opportunity to comment. But today, the most important parts of the Fed’s process happen behind closed doors, shielded from public view.

In my experience as a Fed attorney, it was common for a bank or its law firm to have private conversations with Fed representatives to informally vet a proposal before signing a merger agreement. If Fed representatives raised concerns about a proposal, the bank might not pursue the deal. But when Fed representatives expressed no reservations, the bank could enter a merger agreement with the Fed’s implicit blessing.

Testifying before the Senate Banking Committee in February, Fed Chair Jerome Powell acknowledged that these private conversations still occur. Powell, however, insisted that Fed representatives discourage a bank from filing a merger application only when “it’s clear that there’s a statutory problem” that would preclude approval.

But sophisticated banks like BB&T and SunTrust do not need to consult with the Fed to identify statutory merger barriers, such as deposit and liability caps. They pay their law firms to do that. Instead, it is much more likely that potential applicants consult confidentially with the Fed about discretionary issues like fair-lending performance and risks to financial stability — issues on which the public might offer valuable perspective.

To be sure, the Fed eventually solicits public comment after a bank executes a merger agreement and files a formal application. The problem, however, is that private conversations preceding a formal filing can create internal momentum within the Fed. After Fed representatives give a bank the go-ahead to announce an acquisition, the deal becomes difficult to stop.

In rare instances, Fed staff develops concerns about a proposal after a bank files a formal application. In such cases, Fed staff privately suggests that the bank withdraw its application, with no public explanation.

The secretive vetting of bank merger proposals has become so extreme that the Fed has not publicly denied a merger application in more than 13 years. This private process — in which merger proposals are rarely, if ever, derailed after filing — tips the scales heavily in favor of continued consolidation in the banking sector.

The Fed’s second problem is substantive. The Bank Holding Company Act enumerates many factors that the Fed must consider when evaluating a merger application. The BHC Act, however, provides little guidance as to how the Fed should weigh these considerations. Over time, the Fed has chosen to apply the statutory standards in a way that is highly permissive of bank mergers.

Consider, for example, the convenience and needs of local communities. By law, the Fed must consider an applicant’s record of providing credit to low- and moderate-income populations, including its performance under the Community Reinvestment Act.

Traditionally, the Fed has approved a merger when an acquirer’s overall CRA rating is at least “Satisfactory,” even if one or more of the bank’s performance tests is “Low Satisfactory.”

The Fed, however, need not be so deferential to minimally competent banks. Indeed, the Fed could insist on “High Satisfactory” or even “Outstanding” CRA performance evaluations as a condition of bank merger approval. Raising expectations in this way would ensure that banks expand through merger only if they take seriously their obligation to serve diverse populations.

Alternatively, consider the Fed’s new mandate to consider whether a proposed acquisition “would result in greater or more concentrated risks” to U.S. financial stability. To date, the Fed has authorized significant acquisitions by Capital One and PNC under this standard. But past experience and the Fed’s recent research strongly suggest that firms of this size could pose a risk to the economy.

The BB&T-SunTrust proposal would create a firm with more than $440 billion in assets — far more than firms like Washington Mutual, Countrywide and National City, which proved systemic during the crisis. The BB&T-SunTrust deal therefore presents an opportunity for the Fed to rethink its permissive approach to the BHC Act’s financial stability factor.

In sum, the Fed has become a virtual rubber stamp for bank mergers. The Fed’s merger review process is unnecessarily lenient, with serious procedural and substantive shortcomings. The Fed can and should reverse these troubling trends by increasing transparency in its review process —especially in the pre-filing stage — and holding merger proposals to much higher approval standards. The BB&T-SunTrust proposal would be a great place to start.