The Bank Merger Review Process Fails Credit Unions

The financial pages have been awash recently with news of partisan bickering among regulators over the process for review of prospective bank mergers. Attention to this issue could not come at a better time, as the bank merger review process is in dire need of reform.

Despite the passage of the Dodd-Frank Act of 2010, which was meant to reduce systemic risk and place limits on “too big to fail” banks, consolidation in the banking industry has continued unabated. There were 1,616 fewer banking institutions in 2020 as compared to 2010, according to the Federal Trade Commission. Credit unions and other community-oriented financial institutions have borne the brunt of the bloodletting. This market consolidation has been particularly detrimental to retail consumers in underserved communities and small businesses. The time is right for bank regulators to put the brakes on unchecked bank consolidation.

Under antitrust law, the DOJ and banking agencies must consider the competitive effects of a prospective bank merger before approving it. Unfortunately, the review process has become little more than a rubber stamp for merger proposals. For instance, while the Federal Reserve approved 408 proposals in the second half of 2020, it denied none and only recommended withdrawal of a mere seven applications over competitive, managerial or other substantive concerns. Given that both market consolidation and risk correlations in the banking industry have continued unabated for decades, one would expect regulators to substantively reject more than 1.6% of merger applications.

At a time when government agencies and businesses worldwide were either shut down or operating at limited capacity due to the COVID-19 pandemic, it was business as usual for bank merger regulators.  The median processing time for review of merger and acquisition proposals in the second-half of 2020 was 47 days, only four more than in 2019, according to the Federal Reserve. The alacrity with which bank merger applications are processed is remarkable. A brand-new bank with the bare minimum in required capital needs to wait 60 to 120 days for FDIC approval, whereas multinational banks with billions in assets and offices in dozens of countries can expect merger approval in a little over a month.

These results are unsurprising when one considers what actually goes into the merger review process.  Regulators inordinately focus their inquiry on a single metric, the Herfindahl-Hirschman Index (HHI), which measures market concentration. So long as a proposed merger would not increase the HHI metric by over 200, or result in a total HHI score of 1800 or more, “the banking agencies are unlikely to further review the competitive effects of the merger,” as stated by the DOJ. While the HHI can sometimes serve as a reliable indicator of competitive effects, it suffers from a number of flaws that counsel against its continued usage as the prime consideration in the merger review process.

For one thing, the HHI metric fails to consider systemic risk or community impact even though regulators are required by law to consider both of these factors as part of their merger reviews. A merged bank may impose systemic risk on local or broader markets (for instance, due to new derivatives exposures or risk correlations) even if its market concentration technically passes the 1800/200 HHI test. The current process essentially ignores such systemic effects, even though the Dodd-Frank Act added a requirement that regulators consider such effects during bank merger reviews.

Banks have a long history of using mergers as a vehicle to withdraw credit from minority neighborhoods, and divert it post-merger to wealthier neighborhoods. The Community Reinvestment Act was passed to redress these pernicious “redlining” practices. However, the simplistic HHI metric does nothing to account for these unfair practices. Regulators must come to recognize community impact as a non-numerical consideration that simply cannot be properly distilled into a single metric.

Moreover, the HHI is flawed because it can be manipulated by merging firms to evade regulatory scrutiny. In their negotiations with regulators, bank counsel often make “creative” arguments to minimize the size of the relevant market and thereby yield an HHI score that is low enough to pass the 1800/200 threshold. Even absent outright manipulation, HHI scores may provide unreliable data. In some cases, the market itself may be amorphous, or may be highly segmented according to product class or geographic access, such that raw market concentration data are not reliable.

The entire bank merger process must be revised into a discretionary process that accounts for relevant numerical and non-numerical factors. The current system of rubberstamping bank mergers based on a single metric flouts congressional intent, and does a great disservice to credit unions, small businesses and redlined customers.

Akshat Tewary, Esq. is an attorney practicing in New Jersey, a Financial Industry Regulatory Authority arbitrator and President of Occupy the SEC, a non-profit advocating for financial reform.