A just released report by the Federal Reserve Bank of Kansas City describes a banking industry dramatically transformed by consolidation. Authors James Harvey and Kenneth Spong, both policy economists with the Fed, show

that much of the recent merger and acquisition activity in the industry—especially in Fed Distict Ten states Kansas, Nebraska, Colorado, and Oklahoma—has involved smaller, community banks, resulting in fewer banking organizations, which have aggressively extended their geographic reach into new markets, diversified their product offerings, and broadened their customer bases.

According to the report, more than 90 percent of bank and thrift acquisitions occurring between 1994 and 2003 involved target institutions with assets less than $1 billion. Forty-five percent of the acquiring organizations during this period had assets less than $1 billion. Banks and thrifts of this size are community-based organizations. Understanding their role in the consolidation within the industry is critical in evaluating its impact locally.

Harvey and Spong state that the current number of banking organizations in the U.S. is roughly half what it was in 1980. A result of this consolidation is an increasing concentration of total banking deposits among the nation’s largest banking institutions. In 1985, the ten largest U.S. banks held 17 percent of all U.S. deposits. In 2006, that percentage had grown to nearly 45 percent. Further evidence of this concentration of deposits at the top is the finding that the percentage of deposits held by the upper 50 percent of all U.S. banking organizations, but not those among the top 50 individual institutions, declined from 57 to 30 percent in the period from 1980 to 2006. This demonstrates the market power of banking organizations with national and international reach.

Yet, community-based banks and thrifts have not been shut out. While the number of banking organizations has been dramatically reduced, the number of banking offices has even more dramatically increased. In 1980 there were, in the United States, 46,139 banking offices. In 2006 there were 76,861; an increase of nearly 67 percent. In that same period, the number of banking offices in the Fed’s Tenth District rose from 3,247 to 7,339; an increase of 126 percent. 

The authors say that the consolidation of community banking organizations has provided these organizations with opportunities to significantly increase the number of branches they operate. This, together with technological advances, product innovation, and a loosening of banking laws and regulations, has allowed community-based banks to extend their reach into new geographic and demographic markets. Banks and thrifts based in rural areas have opened branches in urban and suburban settings, and city-based institutions have likewise set up  shop in rural areas. These expansion strategies help banks diversify their customer bases. This then allows banks to offer a broader range of products and services, reducing their risk and exposure to any one particular customer segment.

Rural banking organizations appear to derive the most benefit from strategic expansion into urban/ suburban markets. The Fed report concludes that after an initial adjustment period and incurring start-up costs, these organizations enjoy greater operating efficiencies and additional lending opportunities.

Harvey and Spong point out that the wave of industry consolidation and community bank expansion has not played out. They observe that there are many rural-based banks

in smaller, slow-growth markets that are likely candidates for future mergers and acquisitions which will allow these bank to then establish branches in faster-growing, more urbanized markets.