Banking Review 

2005 VOLUME 17, NO. 4 

The U.S. Federal Financial Regulatory System: 

Restructuring Federal Bank Regulation (page 1) 

by Rose Marie Kushmeider 

Most observers of the U.S. financial regulatory system would agree that if it did not exist, no one 

would invent it. Most, however, would also admit that the system–despite all its faults–has served 

both the financial services industry and consumers well. This paper looks at arguments for and 

against reform in the context of changes taking place within the industry and around the world in 

other financial regulatory systems. 

Consolidation in the U.S. Banking Industry:
 

Is the “Long, Strange Trip” About to End? (page 31)
 

by Kenneth D. Jones and Tim Critchfield 

Consolidation has been an enduring trend in the U.S. banking industry for more than two decades. 

This article provides an overview of the structural changes that have occurred and explores the 

empirical research to determine how consolidtion has affected such things as asset concentration, 

competition, banking efficiency and profitability, shareholder value, and the availability and pricing 

of banking services. Finally, the authors speculate on how the current forces of change might affect 

the industy’s structure going forward. 

The views expressed are those of the authors and do not necessarily reflect official positions of the Federal Deposit Insurance 

Corporation. Articles may be reprinted or abstracted if the FDIC Banking Review and author(s) are credited. Please provide the 

FDIC’s Division of Insurance and Research with a copy of any publications containing reprinted material. 

Acting Chairman Martin J. Gruenberg 

Director, Division of Insurance Arthur J. Murton 

and Research 

Deputy Director Donald Inscoe 

Managing Editor Jack Reidhill 

Editorial Committee Christine E. Blair 

Valentine V. Craig 

Rose M. Kushmeider 

Publication Manager Geri Bonebrake 

The U.S. Federal Financial Regulatory System: 

Restructuring Federal Bank Regulation 

by Rose Marie Kushmeider* 

Introduction 

Questions of whether and, if so, how the U.S. 

financial regulatory system—and particularly the 

federal bank regulatory system—should be 

restructured are hardly new. The debate over federal bank regulatory structure and organization 

goes back for nearly a century. Although studies, 

commissions and committees of banking scholars, 

high-level government officials and industry practitioners have been common, change has come 

only sporadically.1 For the most part, the U.S. 

financial regulatory system remains a highly 

decentralized system that has muddled along more 

or less in its present form since the New Deal 

reforms of the 1930s. 

Most observers of the U.S. financial regulatory 

system would agree that if it did not already exist, 

no one would invent it.2 The overlap in tasks 

among federal regulators and between federal and 

state regulators, particularly for banks, creates a 

confusing system that no one building a system 

anew would want to duplicate. That said, most 

observers would also admit that for all its faults, 

the system seems to have served both the industry 

and the industry’s customers well—assuring a safe 

and sound financial system—though the inefficiencies inherent in such a patchwork system 

undoubtedly impose costs. For the most part, 

entities within the financial services industry 

have learned how to operate and even thrive 

under the regulatory system that has developed. 

U.S. consumers enjoy an immense array of financial products and services, and the capital markets 

provide funding for businesses large and small. 

Nevertheless, there is value in taking a fresh look 

at the structure and organization of the U.S. 

financial regulatory system and providing some 

thoughtful review as to how it could function 

more efficiently and effectively. Past studies have 

generally confined themselves to reviewing the 

bank regulatory system, although many have also 

included the regulation of savings and loans 

(S&Ls) and credit unions. Although the present 

study focuses primarily on the federal bank regulatory agencies, it addresses other areas of the federal financial regulatory structure when appropriate. 

* The author is a senior financial economist in the FDIC’s Division of Insurance and Research. The author would like to thank colleagues at the FDIC 

and Robert Pollard for their helpful comments. Steven McGinnis provided 

research assistance for the paper. The opinions expressed herein are those 

of the author and do not necessarily reflect the views of the FDIC. 

1 For a brief overview of past regulatory restructuring proposals, see the 

appendix. 

2 See, for example, FDIC (2003a) and Spong (2000), 15. 

FDIC BANKING REVIEW 1 2005, VOLUME 17, NO. 4 
 

 

Restructuring Federal Bank Regulation 

At least part of the reason for the past focus on 

reform of the bank regulatory structure is that 

until recently, dividing financial services regulation along industry lines was relatively easy to do. 

In addition, banking was the segment of the 

industry with the greatest number of federal regulatory agencies. The financial services industry, 

however, has continued to evolve and become 

more complex. Products and services once provided by distinct industries have become increasingly similar (a process referred to as product and 

service convergence). In fact, the convergence 

that began in the 1970s has not only continued 

but also accelerated as securitization and the 

development of derivatives markets have added to 

the blurring of the once-clear lines among banks, 

thrifts, securities firms and insurance companies. 

This paper will discuss the creation and evolution 

of the U.S. financial regulatory system and compare its structure to that which other countries 

are now adopting for the regulation of their financial services industries. It will then look at past 

regulatory restructuring proposals and the arguments for and against reform. Major issues in 

designing a regulatory structure will be discussed 

and finally some options and a model for financial 

restructuring will be proposed. 

The Structure, Creation, and Evolution of the 

U.S. Financial Regulatory System 

The current system for regulating and supervising 

financial institutions is complex.3 At the federal 

level, commercial banking organizations are regulated and supervised by three agencies—the 

Office of the Comptroller of the Currency 

(OCC), the Federal Reserve System (Federal 

Reserve), and the Federal Deposit Insurance Corporation (FDIC). Thrifts are regulated and supervised by the Office of Thrift Supervision (OTS) 

and credit unions by the National Credit Union 

Administration (NCUA). The federal regulatory 

system also includes regulation of the securities 

industry by the Securities and Exchange Commission (SEC) and the Commodities Futures Trading 

Commission (CFTC),4 regulation of Fannie Mae 

and Freddie Mac by the Office of Federal Housing 

Enterprise Oversight (OFHEO), regulation of the 

Federal Home Loan Banks (FHLBs) by the Federal Housing Finance Board, regulation of the farm 

credit system by the Farm Credit Administration, 

and regulation of pension funds by the Employee 

Benefits Security Administration in the Department of Labor and by the Pension Benefit Guaranty Corporation. The Departments of the 

Treasury (Treasury), Justice (DOJ), and Housing 

and Urban Development (HUD) and the Federal 

Trade Commission (FTC) play ancillary roles. 

Noticeably absent at the federal level is regulation of the insurance industry, which is performed 

exclusively by the states. In addition, each of the 

states regulates financial services providers which 

are chartered or licensed in their jurisdictions. 

The federal financial regulatory system—and 

specifically the dual banking system, that is, the 

system of federal as well as state chartering and 

supervision of commercial banks—did not emerge 

until 1863, when Congress passed the National 

Currency Act, creating the OCC to establish a 

system of national banks.5 Until that time, the 

states had regulated the entities in the financial 

system.6 The second major step in developing a 

federal financial regulatory system was passage of 

3 Regulation consists of the laws, agency regulations, policy guidelines and 

supervisory interpretations under which financial firms operate. Supervision 

refers to the monitoring of the condition of financial institutions and to the 

enforcement of regulations. The bank supervisory system, for example, 

includes: on-site examinations and off-site monitoring of banks and bank 

holding companies, enforcement of banking laws and regulations, and the resolution of problem and failed banks. 

4 The SEC and CFTC oversee numerous self-regulatory organizations—including 

the organized exchanges, the National Association of Securities Dealers, and 

the National Futures Association—that provide supervision and much of the 

regulation for the securities industry. 

5 Technically, the federal government entered into bank regulation in 1791, 

when it chartered the First Bank of the United States. The bank not only 

operated as a commercial bank, but also assumed some of the functions of a 

central bank, such as acting as a fiscal agent for the Treasury. In 1811, however, the bank was not rechartered. In 1816, the federal government chartered the Second Bank of the United States, which also failed to survive. Its 

charter was not renewed in 1836. Not until 1863, when political pressure 

for a uniform national currency mounted, was a permanent federal role established in the banking industry. The National Currency Act was extensively 

rewritten and strengthened in the National Bank Act of 1864. 

6 The earliest banks received their charters through special acts of their state 

legislatures and the states played a limited role in their supervision. With 

the development of “free banking” in the 1830s, which allowed anyone meeting certain standards and requirements to secure a bank charter, states began 

supervising bank operations. 

2005, VOLUME 17, NO. 4 2 FDIC BANKING REVIEW 
Restructuring Federal Bank Regulation 

the Federal Reserve Act of 1913, which created 

the Federal Reserve System. After that, not until 

the Great Depression—the turmoil of 1929 and 

the early 1930s—was there a major impetus for 

federal regulation of the financial system. 

In 1932, Congress passed the Federal Home Loan 

Bank Act, which established the Federal Home 

Loan Bank System. The following year was particularly active witnessing passage of the Securities Act of 1933, the Home Owners’ Loan Act, 

and the Banking Act of 1933. The Securities Act 

addressed the need for disclosure regarding debt 

and equity securities sold in interstate commerce 

or through the mail. The Home Owners’ Loan 

Act established the federal chartering of S&Ls; it 

also gave the Federal Home Loan Bank Board 

(FHLBB) responsibility for regulating, examining 

and supervising S&Ls. The Banking Act of 1933, 

among other things, created the FDIC, which was 

given not only the role of providing a federal system of deposit insurance, but also the role of regulator of insured state banks that were not Federal 

Reserve members.7 

In 1934 Congress passed the Securities Exchange 

Act, the Federal Credit Union Act and the 

National Housing Act. The Securities Exchange 

Act extended the disclosure principles of the 

Securities Act of 1933 to debt and equity securities already outstanding if listed on national 

exchanges, and created the SEC. The Federal 

Credit Union Act provided for the establishment 

of federal credit unions. The National Housing 

Act created the Federal Savings and Loan Insurance Corporation (FSLIC) and provided for the 

chartering of national mortgage associations as 

entities within the federal government.8 In 1935 

Congress passed the Banking Act of 1935, which 

among other provisions, expanded the FDIC’s 

supervisory powers. 

Thus, much of the present federal regulatory system was created in the 1930s. Since then the system has been changed and expanded piecemeal. 

In 1940, the Investment Company Act and the 

Investment Adviser Act brought investment 

companies and investment advisers under SEC 

regulation. In 1956, the Bank Holding Company 

Act brought multibank holding companies under 

Federal Reserve regulation. In 1970, the Bank 

Holding Company Act Amendments brought 

one-bank holding companies under Federal 

Reserve regulation.9 

In 1966, the Bank Merger Act divided the 

authority to approve bank mergers among the 

banking agencies and DOJ, making the banking 

industry the only industry to have its merger 

activity independently reviewed outside the DOJ 

or the FTC. In 1967 the Savings and Loan Holding Company Act Amendments provided for the 

regulation of savings and loan holding companies 

by the FSLIC. In 1970 the Federal Credit Union 

Act Amendments established the National Credit 

Union Administration as an independent agency 

to regulate federal credit unions; it also established federal credit union insurance under the 

National Credit Union Share Insurance Fund. 

Also in 1970, the Currency and Foreign Transactions Reporting Act and the Bank Secrecy Act 

brought the Treasury into the picture, allowing it 

to monitor large cash and foreign-currency transactions. 

In the late 1960s concerns about consumer protection gained prominence as consumer credit 

and consumer credit instruments began growing 

rapidly. These concerns led to the passage of federal laws that expanded consumer protection to 

the financial services industry. In 1968 the Consumer Credit Protection Act, which included the 

Truth in Lending Act (TLA), gave the Federal 

Reserve rulemaking authority for truth-in-lending, although enforcement of TLA is the responsibility of all the federal financial regulators for 

depository institutions and the FTC for non7 The FDIC was given the authority to examine all insured banks, but to prevent regulatory duplication, it confined itself largely to regulating state nonmember banks. 

8 The only association formed was the National Mortgage Association of 

Washington, which eventually became Fannie Mae. See: Frame and White 

(2004). 

9 Especially important to the issue of regulatory restructuring is how banks 

and their holding companies are regulated. Passage of the Bank Holding 

Company Act and its amendments placed oversight of bank holding companies 

(BHCs) with the Federal Reserve. This meant that, effectively, BHC regulation 

was separated from bank regulation; each was put on its own track; the 

result was overlap, duplication, and conflicts of purpose—if not of interest— 

that had not existed previously. Golembe (2000), 3. 

FDIC BANKING REVIEW 3 2005, VOLUME 17, NO. 4 
Restructuring Federal Bank Regulation 

depository lending institutions, such as mortgage 

and finance companies. Also passed in 1968 was 

the Fair Housing Act, which is administered by 

HUD and enforced by the federal financial regulators. In 1970 the Fair Credit Reporting Act was 

passed, which the FTC administers; the federal 

financial regulators examine depository institutions for compliance under the act. 

The S&L crisis of the 1980s led to the establishment of a new federal regulatory agency for 

thrifts: in 1989, the Financial Institutions Reform, 

Recovery and Enforcement Act (FIRREA) abolished FSLIC and the FHLBB and created, in their 

place, the OTS to regulate and supervise thrifts.10 

FIRREA also established the Federal Housing 

Finance Board to regulate the FHLBs. Then in 

1992 the Federal Housing Enterprises Financial 

Safety and Soundness Act created OFHEO to 

oversee Fannie Mae and Freddie Mac, which had 

previously been regulated by HUD and the 

FHLBB.11 

The laws identified above form the legal basis of 

the federal financial regulatory system. The list is 

not exhaustive.12 Various other laws govern the 

regulation of U.S. financial markets and institutions—such as those affecting trusts and pension 

plans. Although many of the newer laws have 

focused on consumer protection, a number of 

others have addressed issues of regulation and 

supervision related to concerns about safety and 

soundness. The latter group includes the International Banking Act of 1978 and the Federal 

Deposit Insurance Corporation Improvement Act 

(FDICIA) of 1991.13 The Gramm-Leach-Bliley 

Act of 1999 (GLB) formalized the use of functional regulation for financial services conglomerates and entrusted supervision of Financial 

Holding Companies (FHCs) to the Federal 

Reserve.14 The Sarbanes-Oxley Act of 2002, in 

addition to addressing issues of corporate governance, expanded the powers of the SEC and 

established the Public Company Accounting 

Oversight Board. 

This complicated regulatory structure came about 

because financial regulation has been responsive 

to several traditional themes in U.S. history.15 

Among them are a distrust of concentrations of 

financial power, including a concentration of regulatory power; a preference for market competition; and a belief that certain sectors of the 

economy should be ensured access to credit, a 

belief that has led to a multiplicity of niche 

providers of credit. The nation’s complex regulatory structure was designed to deal with all of 

these sometimes conflicting objectives. 

It is precisely because the patchwork nature of the 

system remains an artifact of U.S. politics that 

there has been no comprehensive overhaul of the 

federal financial regulatory system.16 Despite the 

complexity of the system and the resulting 

plethora of proposals for change, concerns about 

concentrations of power, preservation of the dual 

banking system, and the role of the central bank, 

among other issues, dominate the debate, now as 

in the past. The repeated failure of proposals to 

reform the system suggests how sensitive the 

issues are for the many varied interest groups 

involved.17 

10 The insurance function for savings associations was transferred to the FDIC. 


11 Although Fannie Mae and Freddie Mac have one regulator and the FHLBs
 

have another, all of them constitute the housing GSEs (government-sponsored
 

enterprises).
 

12 See Spong (2000) for a description of banking regulation and the laws to
 

which banking organizations are subject.
 

13 The International Banking Act applied federal regulation to foreign banks.
 

FDICIA tightened the regulation and supervision of banks and thrifts in a number of ways. Besides establishing specific requirements for bank capital and
 

examinations, it authorized the FDIC to conduct back-up examinations. It also
 

incorporated the Foreign Bank Supervision Enhancement Act under its Title II
 

provisions.
 

14 A discussion of functional regulation is provided below. Briefly, functional
 

regulation is regulation of a common activity or product by a single regulator
 

for all types of financial institutions.
 

15 Horvitz (1982), 44.
 

16 As Golembe (2000) has observed, “In a country possessing immense natural resources, the development of which depended to a considerable extent on
 

financing, banking—how it would be organized and who would control it—
 

became major political issues. Political parties were often formed around, or
 

came apart because of, views on banking. The result was ‘free banking,’
 

‘dual banking,’ and deposit guarantee. All were products of their time, all are
 

still alive, and all help account for the present fragmented regulatory structure.” (p. 3).
 

17 Bush Task Group (1984), 33.
 

2005, VOLUME 17, NO. 4 4 FDIC BANKING REVIEW 
 

Restructuring Federal Bank Regulation 

International Trends in the Regulation of the 

Financial Services Industry 

Despite the lack of impetus for regulatory reform 

in the United States, in many other countries 

reform efforts have taken hold. Although many 

countries continue to regulate and supervise their 

financial institutions through multiple entities 

(ministries of finance, central banks, and specialized independent agencies), in nation after 

nation, serious study has been given to devising 

regulatory arrangements to deal with a new, more 

integrated, financial world. The trend has been 

to bring together in one agency financial supervision and regulation of the major types of financial 

institutions. In addition, many nations are moving the regulatory and supervisory functions outside the central bank.18 

The Rationalization of Financial Services 

Supervision 

Starting in the mid-1980s a number of countries 

examined their financial regulatory structures and 

concluded that changes were needed. 

Researchers at the World Bank recently reported 

that at the end of 2002, at least 46 countries had 

adopted a model of unified (or integrated) supervision, either by establishing a single supervisor 

for their entire financial sector or by centralizing 

in one agency the powers to supervise at least two 

of their main financial intermediaries.19 

In general, countries that have adopted integrated 

supervision believe that a single supervisor is 

more effective than multiple supervisors in monitoring risks across financial institutions and in 

responding to real or potential threats that may 

undermine the stability of a financial system. 

Adoption of the new regulatory regimes has been 

motivated largely by concerns that the old regulatory structures—which were organized by and 

focused on types of institutions—were becoming 

increasingly, and perhaps dangerously, disconnected from the realities of the marketplace. The 

convergence of financial products and services 

means that many of the delineations among products, services, and types of institutions are becoming irrelevant. The new regulatory structures taking shape around the world represent efforts to 

keep supervision meaningful and effective in a 

rapidly evolving financial environment.20 

Although the trend is toward integrated supervision, there is variation in the scope of regulatory 

and supervisory powers the consolidated agencies 

have been given. Of the 46 countries that have 

changed their supervisory structures, only 22 

(beginning with Norway in 1986) have consolidated the regulation and supervision of all financial institutions into a single supervisory 

authority. In the remaining 24 countries the 

powers to supervise at least two of the main 

financial institutions—such as banks and securities firms or securities firms and insurance companies—have been centralized in one agency.21 

(See table 1.) In either case, the structure and 

organization of the supervisory system has been 

rationalized to reflect the belief that fewer supervisors can more effectively monitor and respond 

to risks within the financial system. The United 

Kingdom represents the first approach (a single 

supervisory authority), and Australia represents 

the second (multiple supervisory agencies but 

integrated supervision). 

18 De Luna Martinez and Rose (2003) report that, of the 15 systems they 

examined in detail, 14 have created a separate supervisory agency outside the 

central bank. They go on to warn, however, that not all of the newly created 

agencies are as powerful as they seem. Ministries of finance and central 

banks continue to play a key role in issuing and amending prudential regulations, authorizing licenses, and establishing important laws for the entire financial system. (p. 12). 

19 Ibid. 

20 “Financial innovation and globalization, driven by an interactive process of 

new information technology, competition and deregulation, are, unquestionably, 

progressively blurring the traditional boundaries between different forms of 

financial intermediation. So regulation based on particular categories of institutions has increasingly become overlaid by functional regulation. This has 

made the whole regulatory structure increasingly complex, both for the regulated firms and for the consuming public at large.” George (1998). 

21 De Luna Martinez and Rose (2003). 

FDIC BANKING REVIEW 5 2005, VOLUME 17, NO. 4 
Restructuring Federal Bank Regulation 

Table 1 

Countries That Have Adopted Integrated

Supervision 

Year-end 2002 

Agency Supervising 

Two Types of 

Single Supervisor Financial Institutions 

Austria Australia 

Bahrain Belgium 

Bermuda Bolivia 

Cayman Islands Canada 

Denmark Chile 

Estonia Colombia 

Germany Dominican Republic 

Gibraltar Ecuador 

Hungary Egypt 

Iceland El Salvador 

Ireland Finland 

Japan Guatemala 

Latvia Kazakhstan 

Maldives Luxembourg 

Malta Malaysia 

Nicaragua Mauritius 

Norway Mexico 

Singapore Peru 

South Korea Slovakia 

Sweden South Africa 

United Arab Emirates Switzerland 

United Kingdom Ukraine 

Uruguay 

Venezuela 

Source: DeLuna Martinez and Rose (2003). 

Integrated Supervision with a Single 

Regulator 

The most prominent example of the trend toward 

regulatory consolidation is the United Kingdom, 

whose government moved in 1997 to establish a 

single regulatory authority—the Financial Services Authority (FSA). In so doing, the U.K. 

government decided not only to consolidate all 

financial services supervision within one agency, 

but also to move that function outside the central 

bank. In terms of regulatory restructuring, this 

was the shot heard round the world. Created as 

an independent agency, the FSA is responsible for 

regulating and supervising all forms of financial 

services activity; it combines the regulatory and 

supervisory functions previously carried out by 

nine bodies.22 

In describing the initial steps taken to establish 

the FSA its chairman, Howard Davies, focused on 

the development of the Complex Groups Division. This division has become the lead regulator 

for 40 to 50 institutions—banks and others— 

whose scale of operation is significant within the 

United Kingdom, which have a material international presence, whose products and services span 

a wide area and which are complex or innovative 

and require advanced risk-management techniques. Other institutions are supervised by other 

divisions within the FSA, such as the Banking 

Division or the Insurance Division. Thus, within 

the FSA there is functional regulation. This 

realignment of responsibilities is based on a distinction between wholesale and retail businesses 

and is an attempt to ensure the adequate oversight of a rapidly changing financial services 

industry. 

Integrated Supervision with Multiple 

Regulators 

The Australian model illustrates a supervisory system that has been consolidated, but has multiple 

supervisors. Like the United Kingdom, Australia 

has moved toward regulatory consolidation outside the central bank, but unlike the United 

Kingdom, Australia has drawn a sharp distinction 

between “prudential regulation” (safety-andsoundness regulation) on the one hand, and regulation to ensure market integrity and consumer 

protection, on the other hand. Australia has 

placed responsibility for the two in separate regulators. 

Following the recommendations contained in the 

final report issued by the committee established 

by the government to make recommendations 

(the Wallis Committee), Australia established its 

22 The nine are the Supervision and Surveillance Division of the Bank of England, the Building Societies Commission, the Friendly Societies Commission, 

the Insurance Directorate of HM Treasury, the Investment Management Regulatory Organization, the Personal Investment Authority, the Registry of Friendly 

Societies, the Securities and Futures Authority, and the Securities and Investments Board. 

2005, VOLUME 17, NO. 4 6 FDIC BANKING REVIEW 
Restructuring Federal Bank Regulation 

centralized regulatory system in 1998. Responsibility for market integrity and consumer protection now lies with the Australian Securities and 

Investments Commission (ASIC), while prudential regulation has been vested in the Australian 

Prudential Regulation Authority (APRA). 

ASIC’s jurisdiction extends across institutions 

and the financial system, and covers investment, 

insurance, and superannuation (pension) products. APRA provides prudential regulation of 

superannuation, insurance, and deposit-taking 

institutions. The Reserve Bank of Australia (the 

central bank), although it no longer has supervisory responsibilities for individual institutions, 

retains its responsibilities to protect the payments 

system and the broader economy from inflation 

and financial instability. 

A Need for Reform? Arguments and Past 

Proposals 

Proposals for regulatory restructuring have a long 

history in the United States. The arguments for 

reform focus primarily on the issues of regulatory 

overlap and duplication while the arguments 

against focus on the notion that despite its faults, 

the present regulatory system works well. Virtually every study of the federal financial regulatory 

system has recommended some form of regulatory 

reform. The goal of most of the studies has been 

to streamline regulation within the banking 

industry so that there is less overlap among the 

federal regulators and fewer federal regulators 

examining the same banks and bank holding 

companies. 

Arguments for Regulatory Reform 

As mentioned above, the debate about reform is 

grounded in the complexity of the U.S. financial 

regulatory system. The complexity of the system 

has several undesirable consequences that reformers seek to mitigate or eliminate. 

Overlap and duplication. The system as it has 

evolved entails substantial overlap and duplication in the regulation and supervision of financial 

institutions, especially BHCs. It is common for 

BHCs and their subsidiaries to have more than 

one federal bank regulator and for their roles to 

overlap. For example, in its examination of 

national banks the OCC looks at a bank’s interactions with its nonbank affiliates; the Federal 

Reserve frequently repeats part of this process 

when it looks at nonbank subsidiaries in connection with its inspection of bank holding companies. Further, as the permissible activities of 

financial conglomerates have expanded, so has 

the potential for overlap and duplication between 

bank and other financial services regulators. 

Under GLB, for example, the securities brokerdealer of a financial holding company (FHC) is 

regulated by the SEC, but the Federal Reserve is 

the FHC’s umbrella supervisor. Another often 

cited area of duplication is in antitrust enforcement, which is carried out by the Federal Reserve, 

the DOJ, and the states. 

The overlap and duplication in agency jurisdictions requires agencies to manage their shared 

responsibilities to try to minimize the time and 

money required to perform their tasks. Coordination among agencies is required for dealing with 

failing institutions and for developing uniformity 

in examinations and information collection. The 

difficulty in coordinating regulatory actions and 

procedures, however, results in inefficiencies— 

delaying the resolution of issues. Such delays can 

impose a significant burden on financial institutions, possibly raising the cost of product development or deterring it entirely. 

Overlap and duplication of responsibilities can 

also result in conflicting rulings from the regulatory agencies that can be difficult to resolve and 

that can create opportunities for the same regulation or law to be applied unevenly to different 

institutions—potentially resulting in a less than 

level playing field.23 The current system of regulatory specialization may create artificial advantages or disadvantages for particular types of 

competitors. As financial institutions and the 

products they offer have become more similar and 

23 Bentsen (1994). 

FDIC BANKING REVIEW 7 2005, VOLUME 17, NO. 4 
Restructuring Federal Bank Regulation 

increasingly compete with one another, differences in regulatory controls are much more likely 

to artificially influence the behavior of financial 

institutions and their customers. This may occur, 

for example, when banks, insurance companies, 

securities firms, or others compete in the same 

product arena, but are not subject to a common 

set of regulatory requirements or when those 

requirements are subject to interpretation and are, 

therefore, applied differently by various regulatory 

agencies. 

The conflicting decisions that are possible when 

there is overlap and duplication of regulatory 

authority may also reflect a deliberate attempt by 

one regulator to benefit its constituents or gain 

converts by adopting a permissive regulatory policy—what has been termed a “competition in laxity.”24 What some may see as a competition in 

laxity, however, others may see as part of a 

dynamic process of regulatory competition that 

furthers innovation in the financial services 

industry. 

Unclear authority and lack of accountability. The 

current system also has engendered debate over 

who has the authority to regulate and supervise 

financial institutions and their products and services. In the 1980s, the Federal Reserve and the 

FHLBB engaged in a dispute about who was entitled to have a NOW account.25 The FHLBB 

adopted a more liberal regulation for S&Ls than 

the Federal Reserve adopted for commercial 

banks. More recently, federal bank regulators disagreed with the SEC regarding proposed rules to 

exempt banks from being treated as brokers. 

Although the quality of the resolutions in these 

instances would not necessarily have been better 

had there been only one agency making the decision, when ultimate authority for a particular 

problem is not clearly identified, the regulatory 

system may lose some of its effectiveness and its 

ability to maintain safety and soundness may be 

impeded.26 

In addition to blurring the lines of authority, the 

current federal financial regulatory system makes 

it hard for any one agency to be held accountable 

for its actions or lack, thereof. Such an absence 

of regulatory accountability enables regulators to 

pass the buck but, more importantly, it may leave 

holes in the regulatory structure—regulatory 

gaps—that should not go unfilled. The complicated structure of regulation may lead to some 

problem or abuse not being detected, because a 

particular agency believes the problem lies in 

some other agency’s jurisdiction. Determining if 

there are deficiencies in laws or regulations may 

be difficult when those laws or regulations are 

administered by multiple agencies. 

Arguments against Regulatory Reform 

Critics of regulatory reform proposals have been 

effective at preventing a wholesale restructuring 

of the federal financial regulatory system and are 

likely to continue being effective. Experience 

suggests that the constituency for maintaining the 

status quo is strong. 

Arguments against regulatory restructuring frequently revolve around two notions—that the 

present system has worked reasonably well and 

that a single agency will not assure uniform performance in all supervisory activities. It is hard to 

disagree with these notions. Despite the regulatory burden imposed by the present system, banks 

and other financial services providers appear quite 

profitable and the United States has developed 

the broadest and deepest financial markets in the 

world. In addition, there is much to be said for 

the notion that a single federal regulator may 

become too bureaucratic and unwieldy. 

But the corollary argument—that multiple regulators are necessary to preserve the process of 

dynamic tension in bank rulemaking—seems at 

odds with the changes that have occurred in bank 

regulation and supervision. Over the past 25 

years much effort has been made to bring uniformity and consistency to the federal bank regulatory process. For example, recognizing that insured 

24 Horvitz (1987), 129.
 

25 Ibid, 130.
 

26 Bush Task Group (1984), 9.
 

2005, VOLUME 17, NO. 4 8 FDIC BANKING REVIEW 
Restructuring Federal Bank Regulation 

depository institutions faced multiple federal regulators—with sometimes conflicting rules and regulations, Congress in 1978 passed the Financial 

Institutions Regulatory and Interest Rate Control 

Act. This act created the Federal Financial Institutions Examination Council (FFIEC) to promote 

consistency in the examination and supervision of 

financial institutions.27 

Supporters of the regulatory status quo also cite as 

important the goal of maintaining the dual banking system. Proposals for regulatory restructuring, 

however, have focused on regulation at the federal level and have not challenged the right of 

states to charter and supervise banks. Nevertheless, those opposed to regulatory restructuring 

would argue that having one federal bank regulator would de facto end the dual banking system. 

This argument does not explain the existence of 

one federal regulator for thrifts or credit unions or 

suggest how to deal with the stresses that bank 

mergers and consolidation have placed on the 

viability of the dual banking system. In addition, 

legislation—such as the Depository Institutions 

Deregulation and Monetary Control Act of 1980, 

FIRREA and FDICIA—has reduced the differences in banking regulations and powers between 

state-chartered and national banks and has 

increased the regulatory authority of the federal 

bank regulators vis-à-vis state regulators over 

commercial banks. 

Over the years, a number of those opposed to regulatory restructuring have argued that—despite 

the inefficiencies resulting from a multiplicity of 

regulators—the current system promotes innovative approaches to regulation. The claim is that 

the current system, in effect, maintains a degree 

of checks and balances among regulators, and 

probably results in more opportunities for industry 

innovation and change than would a monolithic 

regulatory structure. The Federal Reserve, in particular, has argued that, “a single regulator would 

be more likely to make sudden and, perhaps, dramatic changes in policy that would add uncertainties and instability to the banking system.”28 

Others would argue, however, that innovation is 

driven by the marketplace, not by the regulators. 

Regulators mostly react to the events that drive 

the regulated institutions and are kept in check 

by congressional oversight, the courts, the press, 

and market pressures.29 

Major Issues in Designing a Regulatory 

Structure: Structural vs. Functional Regulation, 

Umbrella Supervision vs. Consolidated 

Regulation, and the Role of the Central Bank 

Despite the changes made to the financial system 

by GLB, the U.S. regulatory system still largely 

assumes a financial marketplace with well-differentiated products and services and with financial 

services providers that can be categorized by function. Yet many banking, securities, and insurance 

products and services now overlap in purpose, 

effect, and appearance, and financial services 

providers have found numerous ways around the 

restrictions that attempt to confine them to particular regulatory niches. The result is that the 

dynamic financial marketplace is in effect creating organizations that manage their risks and market their products and services as unified 

entities—but are subject to the oversight of a 

comparatively static and complex regulatory 

structure that looks largely at individual pieces of 

larger organizations. In considering how to regulate these increasingly complex entities, choices 

have to be made between structural and functional regulation, umbrella supervision and consolidated regulation, and between whether and, if so, 

to what extent the central bank should be part of 

the financial supervisory system. 

Structural versus Functional Regulation 

Structural or institutional regulation is characterized by having a single agency exercise all of the 

different types of regulatory controls applicable to 

27 The council is composed of the Comptroller of the Currency, one governor 

of the Federal Reserve, the director of the [now] OTS, and the chairmen of 

the FDIC and NCUA. A liaison committee comprised of five representatives 

from state financial regulatory agencies is also included on the council. 

28 See: Board of Governors of the Federal Reserve System (1994), 133. 

29 See, Bentsen (1994), 56. 

FDIC BANKING REVIEW 9 2005, VOLUME 17, NO. 4 
Restructuring Federal Bank Regulation 

a single financial firm. It allows a single regulator 

to examine a firm’s operations as a whole, to evaluate risk across product lines, and to assess the 

adequacy of the firm’s capital and operational systems that support all the business lines. In structural regulation, integrated supervisory and 

enforcement actions can be taken that will 

address problems affecting several different product lines. Structural regulation assumes that the 

financial firm being regulated serves a distinct 

market segment with limited overlap into other 

market segments. 

Functional regulation, in contrast, is regulation of 

a common activity or product by a single agency 

under a common set of rules irrespective of the 

type of institution involved; it may artificially 

divide a firm’s operations into departments by 

type of financial product or service being offered. 

Because structural regulation developed at a time 

when types of financial organizations (commercial 

banks, S&Ls, credit unions, securities firms, and 

insurance companies) provided products and services that were largely distinct from one another, 

structural regulation was more or less equivalent 

to functional regulation. A bank regulator supervised banking products and services while a securities regulator oversaw activities and products in 

the securities industry. Some overlap existed— 

such as in bank trust departments, where bank 

regulators performed the role of securities regulator—but overlap was not pervasive. Although 

many financial services firms still provide niche 

services, for many others the old market distinctions are invalid. 

Structural regulation went unchallenged until the 

1980s. By then, however, defining how one 

financial services firm differed from another was 

becoming more difficult. The advent of money 

market accounts, NOW accounts and share drafts; 

the growth of mortgage activity in commercial 

banks; the development of Section 20 companies; 

and the renewal of interest in the Industrial Loan 

Company charter, among other developments, led 

to the blurring of distinctions between types of 

organizations that had once been largely distinct. 

As the once well-defined lines separating financial services firms were being erased, the way in 

which these entities were regulated became problematic. The development of direct competition 

among different types of financial firms brought 

out the problem of having different regulators 

governing equivalent products and services. The 

regulatory inequities that resulted from this differential regulation hindered some firms’ ability to 

compete and called into question their viability 

vis-à-vis their differentially regulated counterparts. Accordingly, the idea developed that 

financial firms should be regulated along functional lines. 

The idea of applying functional regulation to the 

banking industry was first put forth in a 1982 

Treasury proposal to expand the securities powers 

of commercial banking organizations.30 ThenSecretary of the Treasury Donald Regan proposed 

that commercial banks be required to place their 

securities underwriting and dealing activities in a 

separate subsidiary, which would be subject to regulation by the SEC or National Association of 

Securities Dealers.31 In 1984, the Bush Task 

Group endorsed the concept of functional regulation, stating that all institutions engaged in similar activities should be subject to the same 

regulations. Functional regulation as defined by 

the task group seeks to have each common activity or product regulated by a single agency under a 

common set of rules, irrespective of the type of 

institution involved. The idea is that functionally equivalent products and services should be regulated alike, regardless of the type of entity 

performing the function. GLB proscribed functional regulation for certain affiliates within an 

FHC. 

30 Fein (1995), 91.
 

31 The policy was endorsed by SEC Chairman John Shad (1982).
 

2005, VOLUME 17, NO. 4 10 FDIC BANKING REVIEW 
 

Restructuring Federal Bank Regulation 

Umbrella Supervision versus Consolidated 

Regulation and the Emergence of 

Consolidated Supervision 

In a system of complex financial institutions that 

manage risk across affiliates, the potential exists 

for regulatory issues to be overlooked under functional regulation. Because of this, GLB designated the Federal Reserve as the umbrella supervisor 

of FHCs. Umbrella supervision focuses on the 

collection of information in order to monitor and 

assess the risks that an FHC and its subsidiaries 

impose on an insured depository institution.32 As 

umbrella supervisor, the Federal Reserve may take 

actions against affiliates of banks when those affiliates are deemed to pose a material risk to the 

bank, but the Federal Reserve may only instigate 

such actions in consultation with the affiliate’s 

functional regulator. The Federal Reserve may 

not establish capital requirements for or impose 

limits on the products of functionally regulated 

affiliates of the bank. 

Consolidated regulation, in contrast, is about proscribing actions. The term “consolidated regulation” is generally associated with the panoply of 

regulations and supervisory powers applied to 

BHCs—the authority to set BHC capital requirements; to set limits on or prohibit activities that 

may be conducted in nonbank units of a BHC; 

and to enforce regulatory and supervisory decisions. A consolidated regulator has the authority 

to require the divestiture of affiliates that are 

deemed to pose a safety-and-soundness risk to the 

bank.33 

Over the past decade, the concept of consolidated 

supervision34 has taken hold around the world, as 

recognition has grown that functional regulation 

treats financial institutions as disparate units 

rather than cohesive wholes. In 1991, the Foreign Bank Supervision Enhancement Act 

required consolidated supervision of all foreign 

banks that had operations in the United States. 

In 1992, the Basel Committee on Banking Supervision adopted its Minimum Standards for Consolidated Supervision, establishing the principle 

that a bank should be subject to a supervisory 

regime in which its financial statements are consolidated and subject to review by home country 

authorities. The Joint Forum (comprising the 

Basel Committee for Banking Supervision, the 

International Organization of Securities Commissioners, and the International Association of 

Insurance Supervisors) furthered the trend by 

developing principles appropriate to the supervision of entities that operate within financial 

groups. In 2002, the European Parliament passed 

a directive requiring all financial services firms 

doing business in the EU to be supervised on a 

consolidated basis by a home-country supervisor 

approved by the EU.35 

Indeed, much of the restructuring of financial 

supervision around the world came about because 

of the view that financial conglomerates need to 

be regulated and supervised on a consolidated 

basis. In developing its principles, the Joint 

Forum was concerned that, although individual 

financial companies within a group might be subject to prudential supervision, the consolidated 

financial group might not be subject to appropriate oversight. This lack of appropriate oversight 

could lead to relationships or transactions that 

could pose financial risk to the regulated parts of 

the group. The Joint Forum’s principles were 

developed to ensure that there were no material 

gaps in supervisors’ understanding of interaffiliate 

relationships within a financial group that could 

cause financial instability.36 

Supervision and the Central Bank 

In the United States the issue of the role of the 

central bank and the relationship between monetary policy and bank supervision has proved especially hard to resolve. Proposals to consolidate 

bank regulatory authority outside the central 

32 As Haubrich and Thomson (2005) state, “the umbrella supervisor is 

charged with producing a comprehensive picture of an institution as the collection of its parts, leaving regulation and examination of each holding-company subsidiary to its functional regulator.” 

33 Carns (1995), 2. 

34 The worldwide concept of consolidated supervision focuses on the collection of information as a way to gauge the risk posed by a financial conglomerate. 

35 European Union (2002). 

36 Olson (2002). 

FDIC BANKING REVIEW 11 2005, VOLUME 17, NO. 4 
 

Restructuring Federal Bank Regulation 

bank or to significantly reduce the regulatory 

authority of the central bank have been vigorously opposed, particularly by those within the Federal Reserve. Representatives of the Federal 

Reserve have maintained that such proposals are 

fatally flawed because they would undermine the 

ability of the Federal Reserve to conduct monetary policy, to achieve its mission of ensuring 

financial stability, and to oversee a smoothly 

functioning payments system. According to their 

arguments, “These responsibilities are mutually 

reinforcing and are integrally linked to the banking system.”37 

In discussing the link between monetary policy 

and bank regulation and supervision, representatives of the Federal Reserve argue that keeping 

bank supervision within the central bank allows 

monetary policymakers to better understand the 

relationship between their actions and bank 

behavior. In a study of the usefulness of supervisory data to macroeconomic forecasting, Peek, 

Rosengren and Tootell (PRT) found that confidential information obtained through bank supervision can potentially improve the accuracy of 

macroeconomic forecasts, a tool that is essential 

to the conduct of monetary policy.38 They 

hypothesized, for example, that problems in the 

banking sector might serve as an early indicator 

of deteriorating macroeconomic conditions. In a 

follow-up study, PRT tested to determine which 

institutions could provide the greatest synergies 

for the conduct of monetary policy; they argued 

that these are the institutions the Federal Reserve 

should regulate. They found that state-chartered 

institutions provided the most useful supervisory 

information and they suggested that the Federal 

Reserve should be responsible for supervising 

these institutions.39 A similar study by Feldman, 

Kim, Miller and Schmidt, however, concluded 

that there is no evidence to support the claim 

that confidential supervisory information would 

have improved macroeconomic forecasts in an 

important way.40 

The existence of a link between supervisory information and better economic forecasts would not, 

by itself, prove that the Federal Reserve needed to 

have bank supervisory powers. The Federal 

Reserve currently receives information about the 

majority of banks from the other banking regulators, both state and federal; it directly regulates 

and supervises only 12 percent of banks, representing 25 percent of bank assets.41 PRT 

acknowledge that their argument relies on the 

assumption that information cannot be effectively 

transferred between agencies, an assumption 

championed by officials within the Federal 

Reserve. “Eliminating the Federal Reserve’s regulatory and supervisory function would deprive the 

central bank of complete information about the 

ways that levels of reserves, movements of monetary aggregates, and fluctuations in the federal 

funds rate are being affected by regulatory policy 

and decisions by bank management.”42 

Despite their results, PRT state that Federal 

Reserve staff do not incorporate supervisory information into their forecasts, “possibly because the 

highly confidential CAMEL ratings are not provided to staff involved in the macroeconomic 

forecast.”43 Rather, they find evidence for retaining bank supervisory powers within the Federal 

Reserve by noting that the governors and presidents of the regional Federal Reserve Banks are 

actively involved in bank supervisory issues and 

use this knowledge to alter the internal macroeconomic forecasts. PRT state that supervisory 

information is important only to the extent that 

the Federal Reserve understands the rating 

process and how it may change over time. Likewise, they conclude that the loss of bank supervisory responsibilities might reduce the Federal 

Reserve’s ability to understand the nuances in 

supervisory data and might therefore make the 

data less useful for purposes of monetary policy. 

Nevertheless, PRT warn other countries that have 

reduced their central bank’s oversight role that 

37 Syron (1994), 3. See also Board of Governors (1994), 132–147.
 

38 Peek, Rosengren, and Tootell (1999), 21.
 

39 Peek, Rosengren, and Tootell (2001).
 

40 Feldman, Kim, Miller, and Schmidt (2002). They extend the PRT model to
 

test it out-of-sample; they also extend the period of analysis.
 

41 FDIC (2003b), 14.
 

42 Syron (1994), 7.
 

43 Peek, Rosengren and Tootell (1999), 30.
 

2005, VOLUME 17, NO. 4 12 FDIC BANKING REVIEW 
Restructuring Federal Bank Regulation 

they should be careful to gather the information 

that is provided in supervisory reports. 

Other arguments that have been put forth to justify the Federal Reserve’s continuing role in bank 

supervision have focused on its responsibility as 

the lender of last resort and as overseer of the 

nation’s payments system—roles that make the 

Federal Reserve more sensitive to systemic risk 

than other bank supervisors would be. These 

arguments have stressed the usefulness of supervision, for it provides a kind of hands-on knowledge 

of what is happening in the banking system that 

could not be gotten elsewhere, not even from 

examination reports written by examiners in 

other agencies.44 In a discussion of PRT, 

Bernanke notes his reservations about the arguments for central bank supervisory responsibilities 

but states that the information transfer argument 

is stronger in the context of crisis management, 

when highly detailed and complex information 

must be transferred quickly.45 

The most common argument for placing supervisory responsibility outside the Federal Reserve is 

that doing so would mitigate potential conflicts of 

interest between the conduct of monetary policy 

and supervision of banks. Such conflicts arise, for 

example, in economic downturns as concerns 

about safety and soundness cause banks to be procyclical in their lending behavior while monetary 

policy is trying to be countercyclical.46 Moreover, 

this behavior is reinforced during bank examinations because the number of classified assets tends 

to increase in economic downturns. Regardless of 

whether examination standards are actually tightened during an economic downturn, the number 

of assets classified by examiners is likely to be procyclical. As this happens, banks are likely to 

adjust their lending. Thus the overall effect of 

the examination process may be to intensify the 

business cycle, an effect that would conflict with 

a monetary policy that was designed to be countercyclical. 

It is argued that in such circumstances the Federal 

Reserve could apply moral suasion to bankers, 

urging them to increase lending during a downturn or restrict lending in an upturn. To many, 

however, the idea of the Federal Reserve using its 

leverage as a regulator to persuade bankers to 

alter their lending decisions or to take other 

actions in line with monetary policy is troubling 

and demonstrates the danger of having the central bank regulate and supervise the banking system.47 Although the use of moral suasion as a 

tool of monetary policy has always been discounted in the United States simply because of the difficulty of using it effectively with so many banks, 

the possibility that it could be used effectively 

increases as the number of banks declines and as 

fewer banks hold a greater percentage of the 

industry’s assets. 

To determine whether and to what extent the 

Federal Reserve needs to be involved in the regulation of banks, BHCs, FHCs or some other 

financial service provider, one must judge 

whether the benefits for the Federal Reserve of 

having first-hand information about an institution outweigh the inherent potential conflicts 

when the conduct of monetary policy is combined 

with supervision. Is it possible to get an accurate 

picture of the financial system from information 

provided by others directly responsible for regulation and supervision? Will the central bank have 

the tools it needs to deal with a crisis? In other 

parts of the world the answer has been to place 

supervisory responsibilities outside the central 

bank, but these structures are relatively new and 

have not yet been tested in a crisis. 

44 In discussing how the Federal Reserve managed to avert a banking crisis
 

in New England in the early weeks of 1991, Syron (1994) states that the discount function has many similarities to the work of bank examiners. He
 

explains that both of them involve the examination of loans, appraisals of collateral, and verification of secured interests. “The examiner’s work was critical to our ability to respond quickly to the need for establishing sufficient
 

collateral for discount window borrowing.” (4–5). Syron also argues that
 

other agencies have a more limited focus to their bank examinations—that is,
 

the other agencies focus on the safety and soundness of individual institutions and the exposure of FDIC insurance funds to bank actions. The Federal
 

Reserve, by contrast, must be aware not only of these considerations but also
 

of ways in which problems can spill over to other participants and markets.
 

Syron argues that examiners who focus solely on the safety and soundness of
 

individual banks frequently do not have the training and the interaction with
 

payments operations that are critical in identifying possible systemic problems. See also: Wall and Eisenbeis (1999).
 

45 Bernanke (2001), 295.
 

46 Peterson (1977), 27–8.
 

47 As Bernanke (2001) noted, “Giving the central bank too broad a range of
 

powers may invite abuse. . . . The potential for moral hazard is real and
 

should be a concern for those who supervise the supervisors.” (296–97).
 

FDIC BANKING REVIEW 13 2005, VOLUME 17, NO. 4 
Restructuring Federal Bank Regulation 

Developing a Model for Restructuring the 

Federal Financial Regulatory System 

In thinking about a restructuring of the federal 

financial regulatory system, one should begin by 

considering the reasons for regulating the financial system. An overriding parameter of any 

restructuring proposal should be to build a system 

that minimizes access to the federal safety net 

while ensuring that the institutions that are being 

regulated are viable, competitive, and capable of 

meeting the needs of their customers. One 

should also consider how events, which are now 

playing out or which are likely to occur, may propel adjustments to the system—whether incremental or wholesale. 

Goals of Regulation 

Although some would argue that regulation exists 

because of the provision of the financial safety 

net—specifically, access to the discount window 

and deposit insurance—in fact, the evolution of 

the regulatory structure over the years suggests 

that even without a safety net, some degree of 

regulation, particularly to protect consumers, 

would exist. As the federal financial regulatory 

structure evolved, three goals emerged: to ensure 

the safety and soundness of the financial system, 

to foster efficiency within and competition among 

financial institutions, and to protect consumers. 

Ensuring safety and soundness. The principal goal 

of the federal regulation of depository institutions 

is to ensure their safety and soundness and by so 

doing promote stability within the financial system. Operationally, this means that disruptions 

in the financial system should not have a significant effect on aggregate real economic activity. 

Thus, the failure of even a large financial institution should not be a concern unless the failure is 

allowed to propagate or become systemic.48 

Because the provision of deposit insurance eliminates the incentive for insured depositors to monitor and discipline their banks (that is, it creates 

moral hazard), someone else must assume the 

function of monitoring bankers and preventing 

them from taking excessive risks. In the United 

States, this responsibility has fallen to bank regulators who fulfill this function primarily through 

safety-and-soundness regulation and supervision. 

Ensuring a safe and sound banking system and 

promoting financial system stability while undertaking regulatory restructuring require balancing 

the need for effective regulatory oversight with 

the possibility that too much regulation can have 

the opposite effect—too much regulation can 

hinder an entity’s ability to compete or induce it 

to undertake risky activities that it would otherwise not undertake. Fulfilling this goal also 

requires developing a system that limits the 

extension of the financial safety net in order to 

encourage market, as well as regulatory, discipline. 

Fostering efficiency and competition. Fostering efficiency within and competition among regulated 

institutions so that customers are provided quality 

products and services at competitive prices is 

another goal of regulation. Efficiency and competition are closely linked. Efficiency is promoted 

by fostering fair and equal competition among 

firms. In a competitive financial system firms 

must operate efficiently in order to keep their customers and remain in business. Competition also 

spurs innovation. 

To maintain a competitive system, regulators must 

be concerned with such issues as the prevention 

of excessive concentration of economic power, 

and the ease of entry into financial markets. Regulators must also consider the allocation of 

resources among financial firms, promoting competitive standards that do not differ significantly 

among financial institutions and that do not 

place some financial firms at a disadvantage relative to others—what has otherwise been termed, 

maintaining a level playing field. Another goal of 

regulatory reform, therefore, should be to foster 

efficiency in regulated entities and to ensure a 

level playing field for all competitors. 

Protecting consumers. Protecting consumers 

(including consumers as investors) is the third 

goal of federal financial regulation and covers 

48 Hoenig (1996), 7. 

2005, VOLUME 17, NO. 4 14 FDIC BANKING REVIEW 
 

Restructuring Federal Bank Regulation 

such concerns as enforcing contracts, protecting 

consumers against fraud, and providing full and 

accurate information on the terms and conditions 

of obtaining credit or purchasing financial products. Much of the legislation and regulation in 

this area is concerned with maintaining market 

integrity—providing meaningful disclosure in 

order to afford consumers and investors a basis for 

comparing and making informed choices among 

different products and services. Equal treatment 

and equal access to credit are also important 

objectives. More recent legislation focuses on privacy concerns. 

As discussed above, consumer protection regulation in the financial services industry is administered by a variety of agencies, and can result in 

differential regulation and the inequitable treatment of firms competing in the same market. 

Members of the public can suffer too, if they 

receive different levels of protection when they 

purchase similar products or services from different financial firms, or if differences in the application of laws and regulations hinder their ability to 

compare products and services. Here too, 

rethinking the regulatory system in light of the 

realities of the changing marketplace could lead 

to better consumer protection. 

Future Problems Will Affect the Regulatory 

Structure Debate 

Regardless of whether one believes that regulatory 

reform is likely, events and issues are sure to stimulate discussion of it in coming years. Among 

such issues are funding for the OCC and OTS,49 

disagreements between the federal and state 

banking regulators over rights of preemption,50 

questions over how financial firms should be regulated for compliance with anti-money laundering 

and other anti-terrorist financing regulations,51 

growth in the number of issues that cross the lines 

separating functional regulators,52 the need to 

provide consolidated supervision for financial 

service firms that are interested in operating in 

the European market,53 consideration of the 

expansion of the products and services offered by 

ILCs,54 and a widening of the differences between 

the largest banking organizations and the rest of 

the banking industry, including differences 

between them in risks posed. 

Options for Restructuring the Federal 

Financial Regulatory System 

The options for restructuring the federal financial 

regulatory system outlined below range from the 

least intrusive and most easily accomplished 

reforms—ones that regulators could undertake 

themselves or that require little legislative 

change—to a full-scale restructuring of the federal 

financial regulatory system. There are valid arguments for taking either approach or even for finding some middle ground, such as a thorough 

restructuring of only federal bank regulation 

rather than of the entire financial regulatory system. Within each option there is room for debate 

over how regulation might be structured—for 

example, which financial entities might be 

included. 

49 Consolidation among banks has affected the funding of both the OCC and 

OTS and has raised questions about how state banks are charged for their 

own supervision. Additionally, as the thrift industry continues to shrink, the 

role of the OTS becomes more problematic: legislation has taken away the 

advantages of operating thrifts, and a declining industry is unlikely to be able 

to support an independent agency. 

50 Both the OCC and OTS have been active in preempting certain state consumer laws affecting the institutions they regulate. See: OCC (2003). 

51 Recent controversies regarding the vigilance with which anti-money laundering and anti-terrorist financing laws have been enforced by bank regulators 

have led to questions about whether this function should be administered elsewhere. Administration of these laws is the responsibility of the Treasury and 

involves coordination with many agencies, both in the United States and 

abroad. 

52 As banks, securities firms and insurance companies continue to find ways 

to compete with one another, it will become impossible to separate banks 

from the larger financial services industry of which they are a part. Thus, 

issues will arise between regulators over how similar products and services 

are regulated and who has ultimate jurisdiction over them. For example, the 

SEC and federal banking regulators have differing views on the issue of how 

to apply brokerage rules to banks. 

53 For BHCs and FHCs and their subsidiaries operating in the EU, the Federal 

Reserve provides consolidated supervision; however, other financial service 

providers operating in the EU will be regulated by the EU if they do not have 

a consolidated supervisor. The SEC has issued a proposal to provide consolidated supervision for broker-dealers that meet minimum capital requirements; 

one of their reasons for doing so is to allow these broker-dealers to meet the 

EU requirements. Similarly, the OTS has designated itself the consolidated 

supervisor of thrift holding companies. 

54 Questions about the regulation of ILCs have increased as the number of 

commercial companies and others that are not regulated as BHCs seek to 

acquire this charter. For a further discussion of the issues posed by ILCs and 

the mixing of banking and commerce, see: Blair (2004). 

FDIC BANKING REVIEW 15 2005, VOLUME 17, NO. 4 
Restructuring Federal Bank Regulation 

An Incremental Approach to Regulatory 

Restructuring—What Can Regulators Do? 

Given the difficult political questions that would 

have to be resolved if the federal financial regulatory structure were to be restructured, a number of 

observers have recommended that any approach 

taken be incremental. The benefit of an incremental approach (which would involve simplification rather than consolidation) is that it would 

be likely to spark less debate that would stymie 

action and it would not limit the options for later 

reform. Simplification (such as eliminating 

redundancies in current supervisory policy) would 

not tread on the dual banking system, nor would 

it limit the central bank’s authority to obtain 

whatever data it might need to play its desired 

role in the nation’s financial system. Simplification promulgated by the agencies themselves 

would give decision makers time to evaluate and 

correct their actions as they went along. It might 

also be achievable because it would require neither legislation nor a crisis. 

At a conference hosted by the FDIC a number of 

speakers made explicit suggestions for initiatives 

that the regulatory agencies could undertake 

themselves.55 Chief among these were for the 

agencies to develop ways of sharing resources and 

various kinds of expertise. It was suggested, for 

example, that the Federal Reserve could take the 

lead in setting and enforcing risk-based capital 

rules, and the OCC could take the lead in defining and enforcing rules for the sale of non-deposit 

investment products. Under such a scheme, 

other regulators with jurisdiction over an institution would be required to abide by the judgment 

of the lead agency in the specific area. Disputes 

would be resolved among the agencies, each of 

which would have the right to review reports generated by the others. Other suggestions along this 

line included having the regulatory agencies contract with other regulatory agencies when in need 

of specialized expertise rather than building it inhouse or having regulators establish cross-agency 

teams to supervise specialized institutions regardless of a particular institution’s charter.56 

Another way for agencies to streamline regulation 

would be to improve the rulemaking process. Disagreements and inconsistencies among the regulatory agencies make for bad policy, increased 

confusion, and increased costs for supervised institutions.57 It has been proposed that the federal 

financial regulatory system move toward integrated rulemaking while maintaining separate supervisors.58 Other suggestions are for the agencies to 

specify what regulations are outmoded and how 

they can be changed. The EGRPRA project currently headed by the FDIC is making progress in 

this area.59 

Overhead is another area where regulators may be 

able to achieve efficiencies and reduce the cost of 

regulation, both for themselves and for the firms 

they regulate. For example, each of the federal 

bank regulators maintains its own headquarters 

and regional offices, its own administration and 

personnel staff, its own computer system, its own 

contracting offices, its own data collection and 

dissemination facilities, its own economic analysis 

and research function, and its own training facility. The FDIC has estimated that the OTS, the 

OCC, and the FDIC spend in total more than 

$200 million annually on backroom operations to 

support their supervisory activities.60 Sharing 

these functions may be one way to reduce costs, 

increase the sharing of information among the 

bank regulators, and ease the regulatory burden 

on the industry. 

Comprehensive Restructuring— 

A Possible Model for Reform 

An approach that contrasts with the incremental 

option is to think about how one would develop a 

system of federal financial regulation if one were 

55 FDIC (2003a).
 

56 Stern in FDIC (2003a).
 

57 Lazio in FDIC (2003a).
 

58 Bair in FDIC (2003a).
 

59 The EGRPRA project refers to reviews the regulatory agencies must conduct
 

every ten years under the Economic Growth and Regulatory Paperwork Reduction Act.
 

60 Powell (2002).
 

2005, VOLUME 17, NO. 4 16 FDIC BANKING REVIEW 
Restructuring Federal Bank Regulation 

starting anew. Such an attempt at comprehensive 

reform raises complex issues regarding dual banking (or more generally, the role of the federal and 

state governments in regulation); deposit insurance and the extension of the financial safety net; 

and the role of the Federal Reserve. Many proposals have foundered because they were unable 

to generate consensus on these issues. The model 

presented here will undoubtedly also spark controversy, but nevertheless presents a framework 

for comprehensive reform. The discussion is 

based on three assumptions: that the dual banking 

system will remain; that the Federal Reserve will 

intervene in a systemic crisis and needs the tools 

to do so effectively and efficiently; and that the 

deposit insurer needs to be able to control its risk. 

The model will have to deal with three questions. 

The first concerns financial conglomerates, the 

second concerns the two-tiered nature of the 

banking industry, and the third concerns the relationship between consumer protection regulation 

and prudential (safety-and-soundness) regulation. 

Banks have been subject to the most rigorous regulation and supervision in the financial services 

industry mainly because of their “special” 

nature,61 but financial modernization and the 

movement toward financial conglomerates have 

lessened the special distinctions between banks 

and other financial service providers, and have 

increased the types of financial organizations that 

may be capable of posing a systemic risk to the 

financial system. Many of these large financial 

conglomerates do not fall under the purview of 

the safety-and-soundness regulation of the federal 

bank regulators. Accordingly, in designing a 

financial regulatory system, one needs to decide 

whether these entities should be regulated in the 

same manner as BHCs or whether the regulation 

of BHCs should change to be more like that currently applied to nonbank financial conglomerates. However the issue is resolved, regulatory 

restructuring should be concerned with creating a 

more uniform approach to all large financial conglomerates.62 

The second important issue when one is modeling 

a regulatory system is how to deal with the fact 

that financial products and services are provided 

by a two-tiered industry. Over the past decade 

the introduction of new products and services, 

the process of product and service convergence, 

and the ability of banks to expand their operations across state lines have created a bifurcated 

banking industry. Current regulatory practice recognizes this bifurcation and makes some adjustments for it.63 In considering reform of the 

regulatory system, however, one must consider 

whether these adjustments are adequate, or 

whether the differences between “small” and 

“large” financial service providers warrant separate regulatory and supervisory treatment. As former FDIC Chairman Powell has asked, “How do 

we design safety-net arrangements to work most 

effectively in an industry consisting of a few large 

banks on one side and thousands of community 

banks on the other?”64 

The last question affecting the model outlined 

below is whether consumer protection regulation 

and investor protection (termed market integrity) 

regulation would be more effectively and efficiently administered by those who administer 

safety-and-soundness regulation or by an independent entity. As the discussion above of the 

U.K. and Australian systems indicates, opinions 

differ. 

The model that follows would reconfigure the 

current system of federal financial regulation into 

four independent agencies. The first (Agency A) 

would administer all consumer protection regulation for the financial services industry. The second and third would administer the 

safety-and-soundness regulation deemed necessary 

for federally insured depository institutions and 

their parent companies and affiliates. One of the 

two would administer the regulation for small and 

noncomplex institutions (Agency B); the other 

61 The special nature of banks has been widely discussed. It focuses particularly on the ability of banks to offer transactions services and administer the
 

payments system, their role as providers of backup liquidity to the economy,
 

and their role as transmitters of monetary policy. See: Corrigan (1982), 2–24.
 

Banks also have access to the federal financial safety net.
 

62 See, for example, Raines (2004) and McDonough (1997).
 

63 See: Powell (2004) and Meyer (1999).
 

64 Powell (2004).
 

FDIC BANKING REVIEW 17 2005, VOLUME 17, NO. 4 
Restructuring Federal Bank Regulation 

would administer the regulation for large or complex institutions (Agency C).65 The fourth 

agency (Agency D) would administer the federal 

deposit insurance programs for all insured depositories. In addition, the Federal Reserve would 

have authority to require information from or 

conduct examinations of any financial institution 

deemed to pose a systemic risk to the financial 

system regardless of its insurance status. As 

described later, the model also considers antitrust 

enforcement and state-chartered institutions. 

The model is based on the size and the degree of 

complexity of a particular financial organization. 

The vast majority of financial organizations are 

not large and complex, and for this majority, regulation of the insured financial entity without the 

need for consolidated regulation or umbrella 

supervision of the parent company should be sufficient. For large or complex organizations, however, an additional layer of supervision (in the 

form of umbrella supervision of the parent company) is needed to ensure that risk is managed 

between entities. 

The key question, therefore, is no longer which 

industry a financial organization fits into, but 

whether the institution is large or complex. In 

any event, for all institutions a case could be 

made for putting consumer and investor protection in the hands of a single regulator (that is, for 

functional regulation). Much of the regulation 

protecting consumers crosses industry lines and in 

these areas consumers of financial products would 

likely find it easier to deal with one regulator 

rather than with the current maze of regulators. 

Consumer protection and market integrity regulator. 

The regulator for consumer protection (Agency 

A) would administer federal consumer-related and 

investor-related regulations for all financial service providers. This agency would take over the 

regulation and supervision of depository institutions with respect to consumer protection laws 

and would administer the current functions of 

such agencies as the SEC, the CFTC, the 

Employee Benefits Security Administration of the 

Department of Labor, and the Pension Benefit 

Guaranty Corporation, among others. 

Over the past several years, emphasis has also 

been placed on obtaining strategic law-enforcement information gathered from reports supplied 

by a variety of financial services firms. Enforcement of the Bank Secrecy Act and other antimoney laundering and anti-terrorist financing 

laws, currently carried out by federal bank regulators in conjunction with the Treasury and the 

Department of State, among others, could also be 

consolidated under this regulator. 

Safety-and-soundness regulator for relatively small, 

noncomplex insured depository institutions. This 

agency (Agency B) would be the federal safetyand-soundness regulator for relatively small, noncomplex insured depository institutions regardless 

of charter.66 This regulator would have the 

authority to grant federal charters, establish capital requirements, enforce prompt corrective 

action, collect information necessary for the timely monitoring of the institution, and take action 

to ensure that firewalls were not breached. 

If insured depository institutions were part of a 

larger organization, they should be separate affiliates within a holding company structure. Administration of consumer protection regulation for 

the insured depository institutions and any nonbank affiliates would be functional.67 The parent 

holding company would be unregulated, although 

it would be required to provide such information 

as would be necessary for the regulator to determine that the firewalls were not being 

breached.68 This information would be obtained 

65 Complexity refers to the scope of products and services offered by the the 

financial entity and the degree of risk inherent in those products and services. 

66 The size of the institution is based on that of the insured entity or sum of 

entities, if there are multiple affiliated insured institutions. Although the exact 

definition would have to be determined, a possible definition of a relatively 

small, noncomplex insured depository is “an institution with less than $5 billion in assets, with a relatively simple balance sheet (that is, an institution primarily engaged in providing traditional products and services according to its 

charter type), with no significant off-balance-sheet exposures, and with a minimal reliance on intangible income sources.” [Daniel Nuxoll (senior economist, 

FDIC) in discussion with author. 2003.] 

67 They would be regulated by the agency in charge of consumer protection 

and by any appropriate state authority. 

68 Consolidated regulation currently exercised over BHCs would be abandoned. 

In 1987, an FDIC study concluded that banking companies could be allowed to 

offer a wider variety of products because banks could be insulated from the 

risks associated with nonbank affiliates without the need to spin a regulatory 

web around the entire organization. FDIC (1987), 101–2. 

2005, VOLUME 17, NO. 4 18 FDIC BANKING REVIEW 
Restructuring Federal Bank Regulation 

through supervision of the regulated financial 

entity. 

Safety-and-soundness regulator for other insured 

depository institutions. This agency (Agency C) 

would be the federal safety-and-soundness regulator for insured depositories that are deemed large 

or complex or that are part of a large, complex 

financial conglomerate.69 As above, the insured 

depository institutions should be separate affiliates 

within the holding company structure. Also, as 

above, the regulator would have the authority to 

establish capital requirements, enforce prompt 

corrective action, collect information necessary 

for the timely monitoring of the institution, and 

take whatever action was needed to ensure that 

firewalls were not breached. 

In addition, this regulator would exercise umbrella supervision of the parent financial holding 

company and of the nonbank affiliates of the 

bank.70 In this context, umbrella supervision 

refers to the ability to collect information about 

the parent financial company and its affiliates; 

and the ability to monitor, assess and act to control the risks imposed on the insured institution 

by other parts of the organization.71 Umbrella 

supervision here would not extend consolidated 

regulation (as currently applied to BHCs) to the 

parent holding company or its affiliates.72 The 

purpose of umbrella supervision would be to 

enhance the effectiveness of the firewalls separating the insured entity from its parent and affiliates. 

This regulator would also apply safety-and-soundness regulation to nondepository financial institutions or organizations that are large or complex 

and that pose a contingent liability to the government. Fannie Mae, Freddie Mac, and the FHLBs 

would fall into this category, for example. 

Regulator for federal deposit insurance programs. 

This agency (Agency D) would be the regulator 

for all federal deposit insurance programs. It 

would administer deposit insurance and receivership functions and would maintain backup supervisory and enforcement authority over insured 

depository institutions. 

Role of the central bank. Although under this 

model the Federal Reserve would no longer have 

a direct role in the supervision of depository institutions, it would maintain and even expand its 

role in controlling systemic risk wherever systemic risk might occur in the financial system. 

As noted above, in a recent speech, Franklin 

Raines discussed the need for having a single 

umbrella financial regulator that would monitor 

systemic-risk issues and set broad policies to control systemic risk.73 Although he did not cite the 

Federal Reserve as this regulator, the Federal 

Reserve is an obvious choice because of its role in 

promoting financial stability and its history of 

intervening in crises involving systemic risk within the financial system. 

To fulfill this role, the Federal Reserve would 

have backup authority to intervene in financial 

markets to ensure financial stability. It would 

retain a supervisory interest in financial institutions that were deemed to pose an ongoing systemic risk to the financial system regardless of 

whether such institutions were supervised by 

another federal regulator. The list of these institutions would be distinguished by their activities 

as well as their size. Examples would be institutions with a substantial market position in a 

financially critical market, such as providers of a 

significant portion of payments-clearing services.74 

69 As one would expect, any depository institution that does not fall into the 

category of small and noncomplex would be placed here. The criterion for 

determining a large or complex financial conglomerate is problematic and is 

beyond the scope of this paper to develop. 

70 For financial companies owned by a nonfinancial commercial parent, 

umbrella supervision would be applied to the financial entities but would not 

extend to the parent commercial firm. The financial entities of these companies would be placed into the appropriate regulatory category on the basis of 

the size and complexity of the operations of the financial entity regardless of 

the parent company. 

71 See Helfer (1997), 10: “In view of the increasing complexity of the financial marketplace, functional regulation alone may not be sufficient to ensure 

effective and efficient oversight of banks and other providers of financial services. . . . Some activities, practices, and intercompany dealings that affect 

the distribution of risk across the organization may go unnoticed if there is 

singular reliance on a functional approach. This suggests a need for some 

coordination and attention to interstitial concerns, such as maintaining accurate information regarding all operations in the organization, and monitoring 

compliance with the rules on intercompany dealings . . . ” 

72 See: Kwast (1996), 746. 

73 Raines (2004), 3. 

74 Litan, in FDIC (2003a). 

FDIC BANKING REVIEW 19 2005, VOLUME 17, NO. 4 
Restructuring Federal Bank Regulation 

Antitrust enforcement. Antitrust enforcement 

would be administered by either the DOJ or the 

Federal Reserve. An argument for having the 

Federal Reserve maintain this function is that in 

applying the antitrust statutes, the Federal 

Reserve would be able to consider the likely 

effects of consolidation on systemic risk. Conversely, antitrust enforcement could be placed 

solely within the purview of the DOJ, and the 

Federal Reserve could make its views known if it 

believed there were systemic risk implications. 

Dual banking and the role of the states. States 

would maintain their role as regulator and supervisor of all state-chartered institutions. For statechartered institutions that did not have a federal 

safety-and-soundness regulator, states would be 

the sole safety-and-soundness regulators. For 

state-chartered institutions that were federally 

regulated and supervised, states would share regulatory responsibilities with their federal counterparts. 

Conclusion 

Reform of the U.S. financial regulatory system is 

far from assured. Matters are complicated by the 

dual system for regulating financial services firms. 

State regulators—including banking commissioners, states’ attorneys general and others—compete 

with their federal counterparts in the regulation 

and supervision of financial services firms. In 

addition, state regulators are the sole supervisors 

of insurance companies, since the United States 

has no national charter for these firms. 

The dynamic tension created by the presence not 

only of state regulators but also of multiple federal 

regulators has led many banking commentators to 

observe that nothing will change the regulatory 

structure of the financial services industry unless 

the politics of the current system are taken into 

consideration. Unlike citizens of other countries, 

who may not worry about concentrations of 

power, U.S. citizens have demonstrated a clear 

preference for decentralization. Further, it is 

commonly said that regulatory reform in the 

United States will be very hard to achieve without a big event to propel it forward. Although 

some tinkering around the edges may be possible, 

wholesale change—which would require congressional action—is not likely in the absence of a 

crisis that would minimize battles over turf and 

unite the entrenched constituencies. 

That said, a number of industry observers have 

speculated that product convergence, or what 

Schooner and Taylor have termed functional 

despecialization, could provide a powerful argument for regulatory consolidation in the United 

States.75 Indeed, many of the countries opting for 

regulatory consolidation have cited concerns over 

an apparently increasing divergence between 

their old regulatory structure and the financial 

industry that the structure was responsible for regulating. The main factors hastening the divergence are financial innovation, a growing 

similarity between financial products, the widespread availability of new information technologies, and globalization.76 

This paper has provided background and a framework for thinking about the issues involved in 

restructuring the federal financial regulatory system. It has reviewed past proposals and investigated ways in which other countries are 

restructuring their systems. Although many 

observers of the banking system doubt that the 

U.S. system will ever undergo restructuring, the 

financial services industry continues to evolve 

and, as it does so, questions continue to be raised 

as to whether the current regulatory system is up 

to the challenge. The task of legislators, regulators and others is to be sure that the regulatory 

system can accommodate financial change yet 

promote the regulatory objectives of ensuring 

safety and soundness, fostering efficiency and 

competition, and protecting consumers, all the 

while maintaining the stability of the financial 

system. Whether a restructuring of the federal 

financial system will eventually occur remains to 

be seen. 

75 Schooner and Taylor (2003), 317-346. 

76 De Luna Martinez and Rose (2003). 

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APPENDIX
 

Past Proposals for Regulatory Restructuring 

This appendix briefly describes the 24 major proposals for regulatory restructuring that have been 

made (but not acted on) since the bulk of the 

federal regulatory system was instituted in the 

early 1930s. 

1. Brookings Study. In the 1930s, the Brookings 

Institution analyzed the federal bureaucracy for a 

Senate committee. Among the recommendations 

was one to reorganize the bank regulatory structure. The FDIC would have become the principal 

federal bank regulator, the OCC would have been 

abolished, and the Federal Reserve’s examination 

and supervisory responsibilities for state banks 

would have been transferred to the FDIC. 

2. Hoover Commission. In 1949, three Hoover 

Commission task forces recommended that federal bank regulatory authority be centralized. One 

task force wanted to transfer the FDIC to the 

Federal Reserve, the second wanted to transfer 

the OCC to the Federal Reserve, and the third 

wanted to fold both the FDIC and the OCC into 

the Federal Reserve. The Commission itself 

opted for a fourth approach, recommending that 

the FDIC be transferred to the Treasury Department. 

3. Commission on Money and Credit. In 1961, 

the Commission on Money and Credit recommended that the functions of the FDIC and the 

OCC be transferred to the Federal Reserve. 

4. Advisory Committee on Banking. In 1962, 

the OCC’s Advisory Committee on Banking proposed eliminating the Federal Reserve’s bank 

supervisory role. All supervisory authority relating to national banks would have been exercised 

by the OCC. All supervisory authority relating 

to state banks would have been exercised by the 

FDIC, which would have been placed within the 

Treasury Department. 

5. Patman Bill. A proposal in 1965 by House 

Banking Committee Chairman Wright Patman, 

H.R. 6885, would have consolidated all federal 

bank regulation, including deposit insurance functions, in the Treasury Department. 

6. Hunt Commission. In 1971 the Hunt Commission, formally titled the Presidential Commission on Financial Structure and Regulation, 

recommended the establishment of three new 

independent agencies: (1) the Administrator of 

National Banks, which would have replaced the 

OCC; (2) the Administrator of State Banks, 

which would have assumed the supervisory functions of the FDIC and the Federal Reserve; and 

(3) the Federal Deposit Guarantee Administration, which would have incorporated the FDIC, 

the FSLIC, and the credit union insurance 

agency. 

7. Compendium of Major Issues in Bank Regulation. In 1975 the Senate Banking Committee 

commissioned a series of papers on issues of structural reform from preparers outside the government. Several papers recommended that the 

FDIC become the primary federal bank supervisor, 

mainly because the deposit insurer has ultimate 

responsibility for all bank supervisory activities. 

8. Wille Proposal. In testimony before Congress 

in 1975, FDIC Chairman Frank Wille proposed 

the creation of a five-member Federal Banking 

Board to administer the deposit insurance system. 

He also called for a Federal Supervisor of State 

Banks to assume thc combined supervisory functions of the FDIC and the Federal Reserve vis-àvis state banks. 

9. FINE Study. In 1975, the House Banking 

Committee held a series of hearings on regulatory 

structure. The product of the hearings was a fourvolume work titled Financial Institutions and the 

Nation’s Economy (FINE) “Discussion Principles.” The study recommended the establishment 

of a Federal Depository Institutions Commission 

to administer all supervisory functions of the 

FDIC, the Federal Reserve, the OCC, the 

FHLBB, and the NCUA. Insurance functions 

FDIC BANKING REVIEW 25 2005, VOLUME 17, NO. 4 
Restructuring Federal Bank Regulation 

would be handled by a subsidiary agency within 

the commission. 

10. Senate Governmental Affairs Committee 

Proposal. In 1977, the Senate Governmental 

Affairs Committee recommended the consolidation of the bank regulatory agencies into a single 

agency. The Consolidated Banking Regulation 

Act of 1979 would have merged supervisory functions into a five-member Federal Bank Commission. 

11. Deposit Insurance in a Changing Environment. In a 1983 study, the FDIC recommended 

the merger of the FSLIC into the FDIC. In addition, it recommended that the FDIC be removed 

from all regulatory functions not directly related 

to safety and soundness. The bank and thrift regulatory and supervisory functions of the Federal 

Reserve Board, the OCC, and the FHLBB would 

be consolidated in a new separate agency. The 

FDIC would have the authority to conduct examinations, require reports, and take enforcement 

actions, but it would limit its attention to problem and near-problem institutions. 

12. Bush Task Group. In 1984, the Task Group 

on Regulation of Financial Services, chaired by 

then–Vice President George H.W. Bush, produced 

Blueprint for Reform. The recommendations 

would have reduced the number of agencies 

involved in day-to-day bank supervision from 

three to two. A new Federal Banking Agency 

(FBA) would continue the OCC’s supervisory 

responsibilities. The Federal Reserve would take 

over supervision of all state-chartered banks 

except banks in states where the state supervisory 

authorities were “certified” to perform the function themselves. Except for about 50 international-class holding companies, the federal 

supervisor—the FBA or the Federal Reserve—of a 

bank would also supervise the parent holding 

company. The Federal Reserve would supervise 

the internationals. The FDIC would lose day-today supervisory authority; its responsibilities 

would be confined to providing deposit insurance, 

although it would be able to examine troubled 

banks in conjunction with their primary supervisor. Finally, functional regulation would play a 

role in that enforcement of antitrust and securities laws would be transferred to the Justice 

Department and the Securities and Exchange 

Commission, respectively. 

13. Depository Institutions Affiliation Act 

(DIAA). The DIAA was a piece of legislation 

that languished in several Congresses in the 

1980s. The act would have established a National Financial Services Committee consisting of the 

chairmen of the Federal Reserve, the FDIC, the 

SEC, and the Commodity Futures Trading Commission; the Secretaries of Commerce and the 

Treasury; the Comptroller of the Currency; and 

the Attorney General. The committee would 

seek to establish uniform principles and standards 

for the examination and supervision of financial 

institutions and other providers of financial services. 

14. National Commission on Financial Institution Reform, Recovery and Enforcement. In 

Subtitle F, Title XXV, of the Comprehensive 

Crime Control Act of 1990, Congress created an 

independent commission to examine the thrift 

crisis of the l980s and to make appropriate recommendations. In its study, Origins and Causes of 

the S&L Debacle: A Blueprint for Reform, the 

commission recommended that federal deposit 

insurance be limited to accounts in “monetary 

service companies,” which would be able to invest 

only in short-term, highly rated market securities. 

A corollary recommendation was that the FDIC 

be made the sole federal insurer of depository 

institutions and the sole federal charterer and regulator of insured institutions. The OCC and the 

OTS would be eliminated. The FDIC would 

remain an independent agency but would be 

required to consult regularly with the Federal 

Reserve and make available to it all pertinent 

information about the condition of insured depository institutions. The Federal Reserve would 

appoint an independent Oversight Board to evaluate new and proposed programs, statutes, rules, 

and regulations. The Oversight Board would not 

take actions on its own but would report its findings and recommendations to Congress and the 

public. 

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15. Modernizing the Financial System. The regulatory structure recommendations of the 1991 

Treasury-led study of the federal deposit insurance 

system largely followed the recommendations of 

the 1984 Bush Task Force. The four federal banking regulators—the Federal Reserve, the FDIC, 

the OCC, and the OTS—would be reduced to 

two, and the same federal regulator would be 

responsible for both a bank holding company and 

its subsidiary banks. A new Federal Banking 

Agency (FBA) within the Treasury Department 

would succeed to the responsibilities of both the 

OCC and the OTS. The FBA would also be 

responsible for the bank holding company parents 

of national banks. The Federal Reserve would 

have responsibility for all state-chartered banks 

and their parent holding companies. The Federal 

Reserve and the FBA would jointly agree on bank 

holding company regulatory policies. The FDIC 

would focus solely on the deposit insurance system and on the resolutions of troubled banks and 

thrifts. 

16. H.R. 1227, the Bank Regulatory Consolidation and Reform Act. This 1993 bill, introduced by Representative Jim Leach, would have 

combined the OCC and the OTS into a separate 

independent federal banking agency that would 

regulate all federally chartered thrifts and their 

holding companies as well as national banks and 

their holding companies unless a holding company’s assets exceeded $25 billion. The FDIC would 

regulate all state-chartered thrifts and their holding companies as well as state-chartered banks 

and their holding companies unless a holding 

company’s assets exceeded $25 billion. Bank 

holding companies with assets above $25 billion, 

and their subsidiary banks, would be regulated by 

the Federal Reserve. 

17. H.R. 1214, S. 1633, the Regulatory Consolidation Act. These 1993 bills, introduced in 

the House by Banking Committee Chairman 

Henry Gonzalez and in the Senate by Banking 

Committee Chairman Donald Riegle, would have 

consolidated federal bank and thrift regulatory 

functions into a single independent commission, 

the Federal Banking Commission. The OCC and 

the OTS would be abolished. The Federal 

Reserve would continue to manage monetary policy. The FDIC would continue to administer 

deposit insurance and exercise conservatorship 

and receivership functions, but its regulatory 

duties with respect to nonmember banks would be 

transferred to the commission. The bills differed 

in several respects. The main differences were 

the number of members on the independent commission and the composition of the FDIC Board 

of Directors. Under the House bill, the commission would have seven members: the Secretary of 

the Treasury, the Chairman of the Federal 

Reserve Board, the Chairman of the FDIC, and 

four public members, one of whom would serve as 

the commission’s chairman. The five-member 

FDIC Board of Directors would be composed of 

the chairman of the commission and four public 

members, one of whom would be the FDIC 

Chairman. (And the commission would have a 

consumer division to enforce consumer protection 

laws.) Under the Senate bill, the commission 

would have five members: the Secretary of the 

Treasury or his or her designee, a Federal Reserve 

Board Governor, and three public members. The 

five-member FDIC Board would be composed of 

the Secretary of the Treasury or his or her 

designee, the chairman of the commission, and 

three public members, one of whom would be the 

FDIC Chairman. 

18. Clinton Administration. In a November 

1993 document titled “Consolidating the Federal 

Bank Regulatory Agencies,” the Treasury Department proposed the consolidation of federal bank 

and thrift regulatory functions in an independent 

Federal Banking Commission (FBC). The proposal is similar to the approaches of H.R. 1214 

and S. 1633. The FDIC would be limited to 

insurance functions, including the handling of 

failed and failing institutions. The Federal 

Reserve would keep its central banking functions 

but would have no primary bank regulatory 

responsibilities, although it would be able to participate in the FBC’s examination of a limited 

number of banking organizations—the ones most 

significant to the payments system. The states 

would continue to regulate the banks they charFDIC BANKING REVIEW 27 2005, VOLUME 17, NO. 4 
Restructuring Federal Bank Regulation 

ter. Thus, state banks would be regulated by both 

the FBC and the states. The FBC would have 

five members: a chairperson appointed by the 

president; the Secretary of the Treasury or his or 

her designee; a member of the Federal Reserve 

Board, selected by the Board; and two other presidentially appointed members. An early 1994 

revision of the proposal expanded the Federal 

Reserve Board’s participation to include joint 

examinations of a sampling of both large and 

small banks, joint examinations of the largest 

bank holding companies, lead examinations of 

holding companies whose main bank is state 

chartered, and backup authority to correct emergency problems in any of the 20 largest banks. 

19. Federal Reserve Board. In January 1994, 

Federal Reserve Board Governor John P. LaWare 

advanced a five-component plan. First, the OCC 

and the OTS would be merged. The resulting 

agency might be called the Federal Banking Commission (FBC). Second, the FDIC would be 

removed as a regulator of healthy institutions. It 

would keep its insurance functions. Third, examination by charter would be replaced by the principle of one organization, one examiner. The 

FBC would examine organizations whose lead 

depository institution was a national bank or 

thrift. The Federal Reserve would examine 

organizations whose lead depository institution 

was state chartered. Fourth, as an exception to 

the previous point, a small number of financially 

important organizations would be treated somewhat differently. The holding companies and 

nonbank subsidiaries would be regulated and 

supervised by the Federal Reserve, whereas the 

bank subsidiaries would be regulated and supervised by the primary regulator of the lead bank. 

Fifth, the Federal Reserve would remain in charge 

of holding company rulemaking and supervision 

as well as the regulation of foreign banks. The 

FBC would write rules for national institutions, 

and the Federal Reserve would write rules for 

state institutions, but the two regulators would be 

required to make their rules as consistent (each 

with the other’s) as possible. 

20. H.R. 17, the Bank Regulatory Consolidation and Reform Act. This 1995 bill, introduced 

by House Banking Committee Chairman Jim 

Leach, is similar but not identical to Leach’s 1993 

proposal (H.R. 1227). The OCC and the OTS 

would be consolidated into a new independent 

agency, the Federal Banking Agency, which 

would regulate all federal depository institutions 

(except those that are subsidiaries of depository 

institution holding companies regulated by the 

Federal Reserve or the FDIC); savings and loan 

holding companies whose principal depository 

institution subsidiary was a federal savings association; and bank holding companies that had consolidated depository institution assets of less than 

$25 billion and whose principal depository institution subsidiary had a federal charter. The FDIC 

would regulate all state-chartered nonmember 

depository institutions except those that were 

subsidiaries of depository institution holding companies regulated by the Federal Banking Agency 

or the Federal Reserve; savings and loan holding 

companies whose principal depository institution 

subsidiary was a state savings associations; and 

bank holding companies that had consolidated 

depository institution assets of less than $25 billion and whose principal depository institution 

subsidiary was a state-chartered nonmember 

depository institutions. The Federal Reserve 

would regulate all state-chartered Federal 

Reserve–member depository institutions except 

those that were subsidiaries of depository institution holding companies regulated by the Federal 

Banking Agency or the FDIC; bank holding companies that had consolidated depository institution assets of less than $25 billion and whose 

principal depository institution subsidiaries were 

state-chartered Federal Reserve–member depository institutions; and all bank holding companies 

with consolidated depository institution assets of 

$25 billion or more. 

21. Federal Deposit Insurance Act Amendment 

of 1995. House Banking Committee Vice Chairman Bill McCollum included a regulatory restructuring proposal in a bill (H.R. 1769) he 

introduced to capitalize the Savings Association 

Insurance Fund and spread the debt service costs 

2005, VOLUME 17, NO. 4 28 FDIC BANKING REVIEW 
Restructuring Federal Bank Regulation 

of the Financing Corporation to all FDIC-insured 

institutions. The McCollum proposal would consolidate the OCC and the OTS into a new independent agency similar to that in the Leach bill 

(H.R. 17). 

22. The Thrift Charter Convergence Act of 

1995. Representative Marge Roukema included 

a regulatory restructuring proposal in a bill (H.R. 

2363) she introduced to capitalize the Savings 

Association Insurance Fund and spread the debt 

service costs of the Financing Corporation to all 

FDIC-insured institutions. The Roukema proposal provided for the conversion of federal savings 

associations into banks; the treatment of state 

savings associations as banks for purposes of federal banking law; the abolition of the OTS; and the 

transfer of OTS employees, functions, and property to the OCC, the FDIC, and the Federal 

Reserve, as appropriate. 

23. General Accounting Office. In testimony 

before Congress in May 1996, the General 

Accounting Office, based largely on a review of 

foreign bank regulatory systems, made four recommendations for changes in the U.S. bank regulatory system. First, the number of federal agencies 

with primary responsibilities for bank oversight 

should be reduced by consolidating the OTS, the 

OCC, and the FDIC’s primary supervisory responsibilities into a new agency. Second, the Federal 

Reserve and the Treasury Department should be 

included in some fashion in bank oversight. 

Third, the FDIC should have the necessary 

authority to protect the deposit insurance funds. 

Fourth, mechanisms to help ensure consistent 

oversight and reduce regulatory burden should be 

incorporated into the regulatory system. 

24. Financial Modernization, 105th Congress. 

Financial modernization was a topic of broad 

interest in the 105th Congress (1997–1998). As 

reported out of the House Banking Committee in 

June 1997, H.R. 10, the Financial Services Competition Act of 1997, combined elements of several bills, including the House version of the 

Depository Institution Affiliation Act and a 

Department of the Treasury proposal. Regarding 

regulatory restructuring, H.R. 10 would have 

abolished the OTS, merging it into the OCC, 

and would have created a National Council on 

Financial Services composed of the Secretary of 

the Treasury; the Chairmen of the Federal 

Reserve Board, the FDIC, the SEC, and the 

CFTC; the Comptroller of the Currency; a state 

securities regulator; a state banking supervisor; 

and two presidential appointees with experience 

in state insurance regulation. These regulatory 

restructuring measures were not in the version of 

H.R. 10 that was passed by the House in May 

1998, and they were not revived in later versions 

of the bill. 

FDIC BANKING REVIEW 29 2005, VOLUME 17, NO. 4 
Consolidation in the U.S. Banking Industry:
 

Is the “Long, Strange Trip” About to End?
 

by Kenneth D. Jones and Tim Critchfield*
 

In 1995, the Brookings Institution published a 

paper entitled “The Transformation of the U.S. 

Banking Industry: What a Long, Strange Trip It’s 

Been.”1 Using a breathtaking array of facts and 

figures, the paper described in great detail the dramatic changes that had occurred in the U.S. commercial banking industry over the 15 years from 

1979 to 1994. The banking industry was transformed during that period, according to the paper 

(p. 127), by “the massive reduction in the number 

of banking organizations; the significant increase 

in the number of failures; the dramatic rise in offbalance sheet activities; the major expansion in 

lending to U.S. corporations by foreign banks; the 

widespread adoption of ATMs; . . . and the opening up of interstate banking markets.” The paper 

went on to explain that most of these major 

changes in banking could be traced to two developments: (1) the extraordinary number of major 

regulatory changes during the period, from deposit 

deregulation in the early 1980s to the relaxation of 

branching restrictions later in the decade; and (2) 

clearly identifiable innovations in technology and 

applied finance, including improvements in information processing and telecommunication technologies, the securitization and sale of bank loans, 

and the development of derivatives markets. 

Other research would later confirm the paper’s 

assessments and its explanation of the course of 

events in the banking industry over the period 

1979–1994. 

Yet, nearly a decade after the publication of that 

paper, data indicate that the transformation of the 

banking industry is ongoing and that the number 

of banking organizations continues to decline— 

though recently there have been signs that the 

number of organizations is beginning to stabilize. 

In fact, when we take a closer look at the data, we 

find that the rate of decline in the number of 

banking organizations appears to be slowing 

markedly. Indeed, if the data from the past few 

years indicate anything about future direction, the 

rate of decline can be expected to slow even more 

over the next five-year period. Moreover, some 

evidence suggests that this slowdown in the rate of 

decline might presage a return to a relatively stable 

* The authors are in the Division of Insurance and Research at the Federal 

Deposit Insurance Corporation. Kenneth D. Jones is a senior financial 

economist, and Tim Critchfield is a senior financial analyst. The authors wish 

to thank Tyler Davis, Ron Kidd, Terry Kissinger, Steve McGinnis, and Chau 

Nguyen for their valuable assistance. The views expressed in this paper are 

those of authors and not necessarily those of the FDIC. Naturally, any errors 

are the responsibility of the authors. 

1 Berger, Kashyap, and Scalise (1995). 

FDIC BANKING REVIEW 31 2005, VOLUME 17, NO. 4 
Consolidation in the U.S. Banking Industry 

population of banking organizations. Such a result 

would be in sharp contrast to conventional wisdom—which foresees continued consolidation of 

the banking industry in the United States. 

Because this paper is part of a collective review of 

the U.S. banking industry’s past and an anticipation of its future, many aspects of the industry’s 

transformation are discussed in companion papers.2 

Our focus, therefore, is primarily on industry structure: how it has already changed and how it might 

evolve in the future. Accordingly, we begin with 

an updated review of the structural changes that 

occurred in the industry over the two decades 

1984–2003. This should give us a better understanding of the scope of the decline that has taken 

place. We then review the causes of this decline 

and the literature on how the decline has affected 

such things as asset concentration, banking competition, efficiency, profitability, shareholder value, 

and the availability and pricing of banking services. After this analysis of the past, we offer some 

projections of future banking industry structure. 

Overview of Structural Change in the 

U.S. Banking Industry 1984–2003 

Over the two decades 1984–2003, the structure of 

the U.S. banking industry indeed underwent an 

Figure 1 

almost unprecedented transformation—one 

marked by a substantial decline in the number of 

commercial banks and savings institutions and by a 

growing concentration of industry assets among a 

few dozen extremely large financial institutions. 

This is not news. As mentioned above, the 

decline in the number of banking organizations has 

been ongoing for more than two decades and has 

been well documented in the literature.3 Nevertheless, a brief overview will serve to clarify both 

the scope of the decline and the increasing concentration of assets among the nation’s largest 

banking organizations.4 

2 In 2004, the FDIC released its findings from a comprehensive research 

project looking into the future of banking. The study as a whole projects 

likely trends in the structure and performance of the banking industry and 

anticipates the policy issues that will confront the industry and the regulatory 

community in the coming years. Copies of the research papers making up 

the study can be obtained at 

http://www.fdic.gov/bank/analytical/future/index.html. 3 Discussions about the declining number of banks can be found not only in 

the paper already mentioned (Berger, Kashyap, and Scalise [1995]) but also in 

Berger, Demsetz, and Strahan (1999); Hughes, Lang, Mester, and Moon 

(1999); and the Group of Ten (2001). 

4 Data limitations at the level of banking organizations restrict our analysis to 

the years 1984–2003. And because the number of commercial banks alone 

peaked in 1984 at 14,496, we use that year as the beginning of our 

discussion of the consolidation trend, even though in certain respects the 

transformation of the U.S. banking industry may be said to have begun 

earlier. 

1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 

0 

5,000 

10,000 

15,000 

Number of Organizationsa 

Organizations with Assets 

Less than $100 Million 

Organizations with Assets 

Greater than $100 Million 

7,842 

14,884 

Count is year-end and includes only organizations that filed a financial report in the fourth quarter. a 

Number of Banking Organizations, 1984–2003 

2005, VOLUME 17, NO. 4 32 FDIC BANKING REVIEW 
Consolidation in the U.S. Banking Industry 

Industry Size 

At year-end 1984, there were 15,084 banking and thrift organizations (defined as commercial bank and thrift holding companies, independent banks, and independent thrifts).5 By 

year-end 2003, that number had fallen to 7,842—a decline of 

almost 48 percent (figure 1). Distributed by size, nearly all the 

decline occurred in the community bank sector (organizations 

with less than $1 billion in assets in 2002 dollars), and especially among the smallest size group (less than $100 million in 

assets in 2002 dollars).6 Yet the community banking sector 

still accounts for 94 percent of banking organizations (figure 

2). 

Geographically, the decline in the number of banking organizations appears to have been remarkably uniform across a variety of regions and markets. Critchfield et al. (2004), for 

example, examined the decline of community banks across 

four market segments—rural markets, small metropolitan markets, and suburban and urban parts of large metropolitan markets—and found that the declines across all four markets were 

proportionally similar (figure 3). The dynamics underlying the 

declines, however, differed depending on the market. Rural 

areas, for example, saw proportionally fewer mergers and very 

little de novo entry in comparison with both small and large 

metro markets, where a larger number of mergers was partially 

offset by a larger number of new-bank start-ups. 

Figure 2 

Distribution of Banking Organizations 

by Asset Size, Year-end 2003 

Assets Assets Greater than Assets $1 Bil. to $10 Bil. $500 Mil. $10 Bil. 1% 

to $1 Bil. 

Assets 

Less than

Assets $100 Mil.

$100 Mil. to 

$500 Mil. 

40% 

Note: Percentages may not add to 100 because of rounding. 

47% 

6% 

5% 

Overall, the bulk of the decline in the 

number of organizations between yearend 1984 and year-end 2003 was due 

to unassisted mergers and acquisitions 

(see figure 4, which decomposes the 

net change in the number of banking 

organizations into several components).7 In every year but one, mergers and acquisitions were the single 

largest contributor to the net decline 

in banking organizations.8 During the 

entire period, 8,122 individual bank 

and thrift organizations disappeared 

through unassisted mergers and holding company purchases. 

From 1985 through 1992, though, failures also contributed significantly to 

the decline in the number of banking 

organizations (figures 4 and 5). Of the 

2,698 bank and thrift closings caused 

by failure during the entire period 

1984–2003,9 almost 75 percent of 

them occurred in the five years 

1987–1991, when failures averaged 

5 The expansion of banking powers over the period we are 

studying has left few differences between commercial 

banks and savings institutions (thrifts), so unless otherwise 

specified, our analysis combines the two types of 

institutions. Moreover, we focus on top-tier organizations 

rather than on individual institutions in order to avoid 

counting multiple charters belonging to a single corporate 

entity. The count here for year-end 1984 (15,084) includes 

all active organizations, whereas figure 1 (which shows a 

total of 14,884 organizations for year-end 1984) includes 

only organizations that filed a financial report at the end of 

1984. 

6 Asset size classes have been adjusted for inflation using 

the GDP price deflator with 2002 as the base year. 

Hence, the number of banks in 2003 that had less than 

$100 million in assets is comparable to the number of 

banks in 1984 that had less than $66 million in assets. 

7 “Other additions” included in figure 4 were non-FDICinsured institutions that became FDIC-insured, often 

transferring from state insurance programs in the mid1980s. “Other changes” were voluntary liquidations of 

organizations. 

8 The sole exception was 1989, when the savings and loan 

(S&L) and banking crises were near their peak. 

9 This number includes not only 2,262 organizations 

(including multibank holding companies) that were 

eliminated because of failure but also individual charters 

that were merged into other charters with FDIC assistance; 

however, it does not include insolvent institutions that 

remained open with FDIC financial assistance. 

FDIC BANKING REVIEW 33 2005, VOLUME 17, NO. 4 
Consolidation in the U.S. Banking Industry 

388 per year.10 In contrast, from 1994 to 2003 only 66 

institutions failed—a figure that reflects greatly improved 

economic conditions and stronger safety-and-soundness 

regulation. 

The decline caused by mergers, acquisitions, and failures 

was partially offset by the entry of 3,097 new banking 

organizations between year-end 1984 and year-end 2003. 

This number is remarkable, given the overriding downward 

trend. During the entire period, the number of de novo 

bank entrants averaged 163 per year, even though the creation of new banks was suppressed at the height of the 

thrift and banking crises. The number of start-up institutions peaked in 1984, then declined each year until 1993; 

then, as economic conditions improved and more capital 

became available, de novo entry into the banking industry 

resumed and continued through the end of the century. 

Figure 3 

-49 

-53 

-46 

-48 

-52 

-46 

-51 

-48 

-51 

All 

Unit-Bank States 

Non-Unit-Bank States 

Rural Markets 

Small Metro Markets 

Suburban Portions of Large Metro Markets 

Urban Portions of Large Metro Markets 

Markets with Population Growth 

Markets with Population Declines 

0 -10 -20 -30 -40 -50

Source: Critchfield et al. (2004). 

Percentage Decline in the Number of Commercial Banks, 

1985–2003 (Unit- vs. Non-Unit-Bank States and 

across Various Types of Markets) 

Figure 4 

With the beginning of an economic recession in March 2001, the number of new 

charter formations again began decreasing. 

As indicated by the trends in mergers, 

acquisitions, and failures on the one hand, 

and start-ups on the other hand, the pace 

of the decline in the number of banking 

organizations has not been uniform. 

Indeed, graphing the rate of change 

reveals a very strong cyclical pattern, with 

declines occurring at a rate that increased 

in the 1980s, only to slow in the 1990s 

(figure 6). Since 1992 the rate of decline 

in the number of institutions has trended 

consistently lower. (This pattern has 

important implications for our projections 

of the structure of the industry.) 

Industry Concentration 

At the same time that the number of 

banking organizations was decreasing, 

industry assets were increasing. Over the 

1984–2003 period, banking industry assets 

grew from $3.3 trillion to $9.1 trillion—a 

increase of nearly 70 percent in real 

terms.11 Existing assets and asset growth, 

10 The number of failures peaked in 1989, when 536 banks and 

thrift institutions failed. 

11 We determined real growth by adjusting nominal dollars for 

inflation using the GDP chain-type price deflator, with 2002 

selected as the base year. 

-600 

-400 

-200 

0 

1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 

-705 

-806 -769 

-884-828 

-732 

-569 -542-618 -591 -539-487 -473 -545 

-387 

-296 -264 -226 -227 

470 

341 296 283 

190 185 

97 61 47 40 76 111 155 177 220 188 119 88 103 

De Novos 

Other 

Additions 

Failures 

Charter 

Mergers 

Additions 

Subtractions 

Other 

Changes 

Bars Net Change (Line) 

Change in the Number of Banking Organizations,1985 to 2003 

2005, VOLUME 17, NO. 4 34 FDIC BANKING REVIEW 
Consolidation in the U.S. Banking Industry 

Figure 5 however, were not evenly distributed 

9 

77 

119 

271 

536 

3 0 

100 

200 

300 

400 

500 

Number of Failures 

Year 

34 37 40 43 46 49 52 55 58 61 64 67 70 73 76 79 82 85 88 91 94 97 00 03 

Number of Commercial Bank and Savings Institution 

Failures, 1934–2003 

Figure 6 

y = 8E-10x2 - 5E-05x + 0.9218 

R2

 = 0.5213 

-2.00 

-1.50 

-1.00 

-0.50 

0.00 

0.50 

Quarter/Year 

Trend Line 

Rate of Change (Percentage) 

1985 1987 1989 1991 1993 1995 1997 1999 2001 2003

Quarterly Rate of Change in the Number of Banking 

Organizations, 1984–2003 

Figure 7 

Share of Banking Industry Assets by Size Group 

1984 and 2003 

1984 2003 

$500 Mil. 

to $1 Bil. 

6% 

Less than 

Greater 

than $10 Bil. 

42% $1 Bil. to

 $10 Bil. 

30% 

Less than 

$100 Mil. $100 Mil. 

73% 

Greater 

than $10 Bil. 

$1 Bil. to

 $10 Bil. 

13% 

$100 Mil. 2% $100 Mil. $500 Mil. to $500 Mil. 8% to $500 Mil. to $1 Bil. 8% 14% 4% 

across the industry but, instead, were 

becoming more and more concentrated 

among the nation’s largest financial institutions. This trend can be seen in figure 

7, which compares asset share over time 

for each of five size groups during our period. The asset share of the largest size 

group—organizations with more than $10 

billion in assets—increased dramatically, 

rising from 42 percent in 1984 to 73 percent in 2003. In contrast, the share of 

industry assets held by community banks 

(organizations with less than $1 billion of 

assets) dropped from 28 percent in 1984 to 

only 14 percent in 2003; and the smallest 

banks, organizations with less than $100 

million in assets, accounted as a group for 

only 2 percent of industry assets in 2003— 

compared with 8 percent in 1984. 

In terms of deposits, industry concentration has been equally dramatic: a quarter 

of the nation’s domestic deposits are now 

controlled by just 3 organizations (see 

table A.1), whereas in 1984 that same proportion was held by 42 companies. At 

year-end 2003, Bank of America Corporation, the largest holder of domestic bank 

deposits, held approximately $512 billion 

in domestic deposits (9.8 percent of the 

industry) and had $870 billion in assets 

(9.6 percent of the industry).12 Also at 

year-end 2003, the 3,683 banking organizations that each held less than $100 million in assets accounted as a group for only 

$192 billion of industry assets (2 percent, 

as noted above) and $160 billion (3 percent) of domestic deposits. 

Analyzing banking industry concentration, 

Moore and Siems (1998) and Rhoades 

(2000) found that, despite some recent 

12 In October 2003, Bank of America announced that it would 

acquire the nation’s eighth-largest bank—FleetBoston Financial—in 

a $47 billion all-stock transaction. Our numbers are for the 

combined organization based on year-end 2003 data. 

FDIC BANKING REVIEW 35 2005, VOLUME 17, NO. 4 
Consolidation in the U.S. Banking Industry 

increases, national and local measures of concentration had remained, on average, relatively low.13 

This was surprising, given that many mergers had 

been of the within-market type—those most likely 

to result in increases in concentration. Hence, 

despite the heightened merger activity among 

banks over the two decades 1984–2003, it appears 

that current concentration measures generally 

remain below the level where monopolistic behavior might manifest itself. Part of the reason may be 

that deregulatory efforts to lower entry barriers and 

expand bank powers—helped along by advances in 

technology—have resulted in an expanded geographic reach of competitors. Competition from 

nonbank financial market participants also provides an important check on market power. However, Rhoades (2000) does caution that, although 

MSA (metropolitan statistical area) market concentration remains fairly low on average, it has 

nonetheless increased substantially since 1984, and 

the increase suggests that in the future there is 

likely to be a growing number of MSA markets in 

which bank merger proposals raise significant competitive issues. 

Fundamental Causes of Consolidation 

Naturally policy makers, academics, and others 

have wanted to know the “why” of consolidation. 

Why, after decades of seeming to change so little, 

did the industry begin to consolidate and restructure itself so dramatically? There is no single reason for the consolidation trend and no single 

underlying cause. Rather, the trend might best be 

viewed as the result of a combination of macroand microeconomic factors: external forces that 

fundamentally and irrevocably changed the environment in which banks operated, and banks’ 

strategic responses to those environmental forces 

(ostensibly with the goal of maximizing shareholder value). Previous studies of the consolidation 

phenomenon have examined and discussed the 

various factors at considerable length. Berger, 

Kashyap, and Scalise (1995), Berger, Demsetz, and 

Strahan (1999), and Shull and Hanweck (2001), 

in particular, offer broad reviews of the literature.14 

Environmental Factors 

At the macroeconomic level, consolidation has 

been driven by exogenous changes in the banking 

industry’s economic environment, and these 

changes have often worked in concert to encourage consolidation. Foremost among them have 

been globalization of the marketplace, technological change, deregulation, and major macroeconomic events (such as the thrift and banking crises 

of the 1980s and the early 1990s, and the economic and stock market boom of the late 1990s). 

Globalization and technological change have been 

persistent forces for change over the entire period, 

and deregulation (in its various manifestations) has 

been a recurring enabling force. In contrast, the 

strength and influence of major macroeconomic 

events have varied over time. For example, the 

economic forces that led to the thrift and banking 

crises were influential primarily in the middle to 

late 1980s and early 1990s; by the mid-1990s the 

crises were over, and bank and thrift failures were 

no longer a major contributor to industry consolidation. Similarly, the influence of the economic 

growth and stock market boom of the late 1990s 

was largely restricted to a specific period. Hence, 

adding a temporal dimension to the discussion of 

the external influences on consolidation will help 

us not only understand the current trend but also 

formulate expectations about the future. 

Globalization and Technology. Globalization began 

slowly in the aftermath of World War II. After 

that war, the major economies of the world gradually became more connected and interdependent, 

13 Standard measures of concentration include the Herfindahl-Hirschmann Index 

(HHI—defined as the sum of the squares of the individual market shares of all 

banks in the market) and the three-firm concentration ratio (CR3—that is, the 

percentage of deposits accounted for by the three largest banking 

organizations in the market). 

14 Expanded discussions of the macroeconomic forces driving consolidation 

can also be found in Rhoades (2000); Hannan and Rhoades (1992); and Boyd 

and Graham (1998). The microeconomic underpinnings of banking 

consolidation are discussed in Hughes, Lang, Mester, Moon, and Pagano 

(2003), Milbourn, Boot, and Thakor (1999), Calomiris and Karceski (1998), 

and Hughes, Lang, Mester, and Moon (1996). 

2005, VOLUME 17, NO. 4 36 FDIC BANKING REVIEW 
Consolidation in the U.S. Banking Industry 

This trend toward globalization accelerated in the 1970s 

and 1980s—in tandem with the beginnings of what would 

become a revolution in information and telecommunication (ITC) technologies. Indeed, by the end of the twentieth century, technological change would affect nearly 

every aspect of the business of banking: the demand for 

banking services, the character and intensity of sector 

competition, and the very structure of the industry.15 

Through what has been described as “a protracted series of 

technology shocks with order-of-magnitude effects on the 

costs of transmitting and processing information,” 

advances in ITC technologies have created new advantages of scale in production and have lowered barriers to 

entry.16 

Dramatically lowered costs and the ability to transmit 

information almost instantaneously around the globe effectively freed the financial services industry from the constraints of time and place. In the new global financial 

economy, banks, securities firms, corporations, and even 

individual investors became able to transfer huge amounts 

of capital around the globe with the click of a mouse. Yet, 

while these new technologies enabled financial firms of all 

types to exploit innovations in financial and economic 

theory, engineer new products, and implement new techniques for managing risk, they also resulted in a sharply 

more competitive marketplace for banking and financial 

services. To survive and prosper, banking organizations 

needed to respond to this new environment. Consolidation was one response. However, the strict regulatory 

environment that existed before the 1980s largely precluded any dramatic consolidation within the banking industry. 

Not until regulatory constraints were relaxed did consoliFigure 8 

331 

599 

409 

154 

189 

71 

0 

50 

100 

150 

200 

Interstate (Solid) 

100 

200 

300 

400 

500 

600 

700 

Intrastate (Dashes) 

Year 

84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 

0 2 

Number of Commercial Bank Charter Mergers 

Interstate and Intrastate 1984–2003 

dation of the banking industry begin in 

earnest. 

Deregulation. In the early 1980s, policy 

makers began a decades-long process of 

deregulating the banking and thrift industries so that they could be more responsive 

to marketplace realities (see table A.2). 

Over time, these legislative and other 

deregulatory efforts gradually (albeit haltingly) loosened the constraints on the 

industry, thus freeing it to cope more effectively with both the new environmental 

challenges and the heightened competition that resulted. In two areas—banking 

activities and branching—legislative and 

regulatory efforts were particularly important for the consolidation trend: restrictions on permissible banking activities 

were relaxed, and geographic limitations 

on branching were removed. The importance of these two efforts is perhaps best 

illustrated by the spate of interstate mergers that occurred immediately after passage 

of the Riegle-Neal Interstate Banking and 

Branching Efficiency Act of 1994 (figure 

8). Although some researchers have 

argued that much of the merger activity 

associated with the deregulatory process 

reflected only pent-up demand that had 

been long accumulating because of other 

causal factors, there can be no doubt about 

the influence of deregulation on the merg15 For more detailed discussions of technology and the effects it 

has had on the restructuring of the financial services sector, see 

Berger (2003), Berger and DeYoung (2002), the Group of Ten 

(2001), Hunter (2001), Mishkin and Strahan (1999), and Emmons 

and Greenbaum (1998). 

16 Emmons and Greenbaum (1998), 37. 

FDIC BANKING REVIEW 37 2005, VOLUME 17, NO. 4 
Consolidation in the U.S. Banking Industry 

er wave as it unfolded in the United States: if 

deregulation in and of itself was not a primary 

causal factor, it was certainly an essential enabling 

factor.17 

Macroeconomic Events. In the 1970s—even before 

deregulation and before the full effects of the revolution in ITC technologies had been felt—a series 

of macroeconomic shocks combined with the twin 

forces of globalization and technology to dramatically alter the economic environment within 

which banks operated. Indeed, the decade of the 

1970s saw the introduction of floating exchange 

rates, increased volatility in interest rates, oil price 

shocks, stagflation, and unexpected changes in 

other real economic and financial variables. These 

economic conditions, and governmental responses 

to them, began putting stress on the environment 

in which banks and thrifts had successfully operated, unchanged, for many decades. 

In the early 1980s these stresses were intensified by 

double-digit inflation and then by the anti-inflationary monetary policies designed to combat it. 

By mid-decade, wild swings in interest rates, combined with sharp declines in oil and gas prices and 

in the value of real estate, precipitated a series of 

rolling regional recessions that wreaked havoc on 

the nation’s S&L and banking industries. The 

number of failures soared, soon reaching (and then 

far exceeding) levels that had not been seen since 

the Great Depression. But as bank failures rose to 

record levels, so did bank mergers and acquisitions: 

federal regulators responded to the growing number of weak and failing depository institutions and 

shrinking insurance-fund balances by loosening 

their restrictions on mergers. The FDIC even provided financial support to encourage better-capitalized and profitable banking organizations to 

acquire weakened or insolvent institutions. As a 

result, during the 1980s the consolidation movement was particularly strong. 

* * * 

The consolidation of the banking industry continued into, and then through, the 1990s, but it is 

important to note that the forces driving the trend 

in the 1990s differed markedly from the forces 

driving it in the 1980s. Indeed, in many respects 

the 1980s and the 1990s were the worst of times 

and the best of times (respectively) for the banking 

industry. Banks in the 1980s were struggling under 

harshly unfavorable economic conditions and outdated legislative and regulatory constraints. Many 

banks and S&L were unprofitable. Many failed. 

In contrast, the middle to late 1990s saw a convergence of several factors that created an environment extremely conducive to merger activity. 

First, unlike the 1980s, the middle to late 1990s 

were a period when banks were highly profitable, 

flush with cash, and reveling in favorable economic and interest-rate environments. In fact, bank 

performance from 1993 through the end of the 

decade (and beyond) would set multiple records for 

profitability (figures 9 and 10). Second, RiegleNeal’s removal of barriers to interstate banking and 

branching provided opportunities for many organizations to consolidate operations and pursue geographic diversification through acquisitions. 

Third, a record-breaking bull market in stocks 

pushed market valuations of banks and thrifts to 

unprecedented levels, encouraging many banking 

firms to use their stock as currency to purchase the 

hard assets of other banking firms (figure 11). This 

was especially the case when managers believed 

their firms’ own stocks were “favorably” priced. 

Conversely, managers of firms wishing to be 

acquired were able to maximize firm value by selling out at record market-to-book valuations. 

While these conditions persisted, consolidation 

continued at a relatively rapid pace—although it 

was partially offset by a rise in the number of new 

bank start-ups. 

At the end of the decade, however, several events 

appeared to have had a markedly dampening effect 

on bank merger activity and on the pace of indus17 As mentioned, the Riegle-Neal Act (along with regional interstate compacts 

that repealed interstate branching restrictions) had a significant effect on bank 

merger activity and industry consolidation. In contrast, the latest legislative 

initiative aimed at modernizing the financial services industry—the GrammLeach-Bliley Act of 1999 (GLB)—has not had a similar effect. As explained by 

Rhoades (2000), GLB provides for cross-industry mergers between banks, 

securities firms, and insurance companies. However, such combinations are 

likely to be considered by only the largest banking organizations. Moreover, 

by definition, the combination of a banking firm and another type of financial 

services provider does not result in the loss of a bank charter. Hence, the 

combination will have no effect on the number of banking organizations. 

2005, VOLUME 17, NO. 4 38 FDIC BANKING REVIEW 
Consolidation in the U.S. Banking Industry 

Figure 9 try consolidation. First, Y2K-related conReturn on Assets (ROA %) 

0.91 

0.10 

1.40 

0.00 

0.50 

1.00 

1.50 

–0.77 

Year 

34 37 40 43 46 49 52 55 58 61 64 67 70 73 76 79 82 85 88 91 94 97 00 03 

Return on Assets (Percent), Commercial Banks 

1934–2003 

Figure 10 

–5.80 

Return on Equity (ROE %) 

1.55 

15.31 

0.00 

5.00 

10.00 

15.00 

Year 

34 37 40 43 46 49 52 55 58 61 64 67 70 73 76 79 82 85 88 91 94 97 00 03 

Return on Equity (Percent), Commercial Banks 

1934–2003 

cerns might have caused some merger 

plans to be postponed until after the beginning of the new millennium. Then in 

March 2000 the record run-up in stock 

prices reversed itself.18 A year later (in 

March 2001) the U.S. economy entered a 

mild recession. Coincident with these 

adverse economic developments, a significant accounting change in the way mergers were recorded served to discourage 

stock-funded bank merger transactions.19 

Finally, the terrorist attacks on the World 

Trade Center and the Pentagon on September 11, 2001, and the subsequent wars 

in Afghanistan and Iraq adversely affected 

the broader economic and business environments. Nevertheless, consolidation in 

the banking industry continued into the 

twenty-first century, though at a much 

slower rate. 

Microeconomic Factors in 

Merger Decisions 

As we have just seen, at the macroeconomic level consolidation has been influenced by technology, deregulation, 

macroeconomic events, and other environmental factors. But it is the microeconomic factors that, in the aggregate, are largely 

responsible for the consolidation trend. 

These factors are the individual decisions 

by banking firms to pursue a merger or Figure 11 

Year 

118 255 

689 

2,083 

1,691 

2,231 

2,899 

80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 0 

500 

1,000 

1,500 

2,000 

2,500 

3,000 

Value (Base Year 1971 = 100) 

Nasdaq Bank Stock Index 

1980–2003 

acquisition strategy. From a microeconomic perspective, a bank’s decision to consolidate charters—to merge with or acquire 

another firm—should reflect management’s 

18 For the next several years, all the major stock indexes would 

fall dramatically; from March 2000 to March 2003, for example, 

the S&P 500 benchmark fell a cumulative 43 percent. 

19 Financial Accounting Standards Rule 141 (FAS 141) terminated 

the use of pooling-of-interest accounting for business combinations 

after 2001 and required that purchase accounting methodology be 

used instead. Purchase accounting requires a firm to record 

goodwill if the market value of net assets acquired is less than 

the purchase price. Historically goodwill was amortized regularly, 

but now (under FAS 142) companies must test goodwill (and other 

intangibles) for impairment once each fiscal year. A finding of 

impairment may require additional noninterest-expense recognition. 

FDIC BANKING REVIEW 39 2005, VOLUME 17, NO. 4 
Consolidation in the U.S. Banking Industry 

chosen strategy for maximizing or preserving firm 

value in the face of increased competitive pressure 

stemming from a more market-oriented environment. For example, a merger strategy can be based 

on value-maximizing motives, such as achieving 

economies of scale and scope or reducing risk or 

increasing profits through geographic and product 

diversification. Indeed, in a recent survey of bank 

management, value-maximizing motives were most 

often cited as the principal reason to undertake a 

merger.20 

A firm’s decision to merge, however, may also be 

influenced by motives that do not necessarily maximize the firm’s value. Adverse changes in a bank’s 

competitive environment may compel a banking 

firm to undertake an acquisition as part of a purely 

defensive strategy, or merger decisions may be 

based wholly or partly on the self-serving motives 

of managers. (Bliss and Rosen [2001] and Ryan 

[1999], for example, suggest that empire building 

and increased managerial compensation might be 

the primary motive behind some bank mergers.) 

Another motive—suggested by Shull and Hanweck (2001), Penas and Unal (2004), and others—is a desire to obtain “too-big-to-fail” status 

and the funding and other competitive advantages 

that seem to accrue to the largest and most complex banking organizations. 

Just as economic and regulatory conditions in the 

1980s differed significantly from those in the 

1990s, some economists have suggested that the 

motivations behind bank mergers in the 1980s 

were different from the motivations behind the 

mergers of the 1990s. Berger (1998, 106) observes 

that 

Consistent with a change in merger motives, 

many of the merger participants in the 1980s 

focused on expanding their geographic bases to 

gain strategic long-run advantage by getting 

footholds in new locations, rather than on reducing costs or raising profits in the short run. Merger participants in the 1990s appear to be more 

focused on cutting costs quickly through mergers—for example, they often announce goals for 

employee layoffs, branch closings, and total cost 

savings in advance of mergers. 

It may well be that merger motives have changed 

over time. Additional research will undoubtedly 

help us better understand if this is so. 

The Effects of Consolidation 

Perhaps more important than knowing why consolidation has occurred in the U.S. banking industry is understanding what its effects have been on 

the banking industry, its shareholders, and the customers served. In theory, globalization, technology, and deregulation should have resulted in a 

significant increase in competition. Increased 

competition, in turn, should drive value-maximizing managers to seek greater efficiencies through 

consolidation. In other words, if profit-oriented 

managers think that there are economies of scale 

or scope to be gained or that opportunities exist to 

replace inefficient managers at other firms or to 

enhance profitability by servicing customers better, 

a competitive environment will encourage these 

managers to seek such economies or opportunities. 

Of course, the question of whether the current 

consolidation trend has made the banking industry 

more efficient or a better provider of services to 

the banking public is an empirical one. 

Fortunately, the effects of consolidation have been 

a particularly active area of empirical research for 

more than a decade, and a consensus is beginning 

to form. Table A.3 gives a synopsis of these general findings. However, we should first note that 

researchers have faced substantial econometric difficulties in their attempts to test for efficiency and 

other potential gains from consolidation. Pilloff 

and Santomero (1998) and Calomiris and Karceski 

(1998), in particular, have enumerated several 

methodological pitfalls that make it hard to assess 

the effects of consolidation accurately. Among the 

pitfalls are these: (1) because of increased competition, efficiency gains from mergers might not be 

reflected in net earnings; (2) lags in performance 

improvement may be extensive (three to five 

years), especially for mergers motivated by strategic 

20 Group of Ten (2001). 

2005, VOLUME 17, NO. 4 40 FDIC BANKING REVIEW 
Consolidation in the U.S. Banking Industry 

goals such as diversification rather than by a desire 

to cut costs; (3) constructing a believable benchmark (for purposes of comparison) in the midst of 

a merger wave may be difficult; and (4) controlling 

for multiple causal and motivational factors over 

time and across mergers may be difficult. In addition to these methodological difficulties, there is 

also likely to be a problem reconciling the findings 

of studies based on 1980s data with the findings of 

studies that use 1990s data. Furthermore, as our 

chronological account indicates, the causal factors 

(and probably the motivations) driving mergers in 

the 1990s were very different from those driving 

mergers in the 1980s. With these qualifications in 

mind, we now briefly summarize the existing evidence about the effects of consolidation. 

On the positive side, findings to date suggest that 

consolidation has resulted in somewhat greater 

profit efficiency (profit efficiency measures how 

close a bank is to earning the maximum profits 

that a best-practice bank would earn under the 

same circumstances).21 According to Berger 

(1998), profit efficiency is enhanced by mergers 

because the combined firms generally achieve 

greater diversification of their risk exposures 

through a better mix of geographic areas, industries, loan types, and maturity structures. In turn, 

improved diversification might allow the combined banking organization to undertake a portfolio shift from security investments into consumer 

and business loans—activities with higher expected values. Hence, profit efficiency would be 

greater with consolidation because capital is put to 

better use and because greater geographic diversification tends to reduce risk.22 

Findings to date also suggest somewhat greater payment-system efficiency (see Hancock, Humphrey, 

and Wilcox [1999] and Adams, Bauer, and Sickles 

[2002]) and, for institutions that have increased 

their geographic diversification, possibly a lower 

risk of insolvency (Group of Ten [2001] and Berger 

and DeYoung [2001]). Finally, a potential negative 

effect of the reduced number of banking organizations has been avoided: access to banking services 

(including lending to small businesses) seems to 

have been relatively unaffected (see, for example, 

Avery et al. [1999], DeYoung et al. [1998], and 

Jayaratne and Wolken [1999]). 

On the other hand, most researchers—especially 

those focusing on the 1980s and early 1990s— 

have not been able to identify any of the broadbased improvements in cost efficiency that one 

might have expected from economies of scale or 

scope.23 Given that managers most often cite 

gains from increased cost efficiency as the primary 

motivation for strategic consolidations, this finding 

(or the lack thereof) represents a fairly substantial 

puzzle. Some researchers have tried to explain 

away the lack of support for economies of scale by 

citing measurement and econometric difficulties 

and a time horizon too short for making observations. And in fact, a few more-recent studies that 

claim to have overcome some of these obstacles 

have reported results suggesting that scale-related 

efficiency gains in the 1990s have been substantial 

(Hughes, Mester, and Moon [2001] and Hughes, 

Mester, and Moon [1999], among others). Additional investigations into gains in efficiency will 

undoubtedly help solve this puzzle. 

In addition to lacking consensus on cost-efficiency 

gains, empirical work to date has also failed to find 

substantive evidence of other benefits that one 

might hope consolidation would yield. For example, there is little evidence that either consumers 

or shareholders have benefited from consolidation 

in the industry (Shull and Hanweck [2001], Kahn, 

Pennachi, and Sopranzetti [2001], and Prager and 

Hannan [1998]). Rather, there is growing evidence that increases in market power at the local 

level may be adversely affecting consumer prices 

(for both depositors and borrowers).24 And as we 

mention above, there is also some evidence that 

21 Berger’s (1998), concept of profit efficiency includes not only the cost-


efficiency effects of mergers and acquisitions but also the revenue effects of
 

changes in output that occur after a merger.
 

22 For additional evidence on increased profit efficiencies, see Akhavein,
 

Berger, and Humphrey (1997) and Boyd and Graham (1998).
 

23 A number of studies have found little or no evidence of scale economies.
 

These include Stiroh (2000) and Berger, Demsetz, and Strahan (1999).
 

Additional studies with similar findings are listed in table A.3. For the
 

findings on scope economies, see Stiroh (2004), Amel et al. (2002), DeLong
 

(2001), and Demsetz and Strahan (1997), among others.
 

24 See Shull and Hanweck (2001), and Berger, Demsetz, and Strahan (1999),
 

among others.
 

FDIC BANKING REVIEW 41 2005, VOLUME 17, NO. 4 
Consolidation in the U.S. Banking Industry 

managers may be pursuing mergers and acquisitions 

for reasons other than maximizing firm value: 

researchers who have studied the issue have consistently found support for the idea that empire building and increased managerial compensation are 

often primary motives behind bank mergers.25 

Finally, findings from several researchers suggest 

that industry consolidation and the emergence of 

large, complex banking organizations have probably increased systemic risk in the banking system 

and exacerbated the too-big-to-fail problem in 

banking.26 

Thus, despite the many empirical studies of consolidation in the U.S. banking industry, much uncertainty remains not only about the importance of 

the various factors behind the merger trend but 

also about the effects of consolidation on bank 

shareholders and on those who use banking services. Before we can fully understand either the causes of consolidation or all its ramifications, more 

work needs to be done. 

Projections of Banking Industry Structure 

Because banks play an important role in the U.S. 

financial system, changes in the industry’s structure 

are likely to have widespread effects. Hence, for 

planning purposes it would be useful if structural 

changes could be anticipated before they occurred. 

Review of Previous Projections and 

Their Methodologies 

Of the studies that have documented and discussed 

the decline in the number of banks, several— 

including Hannan and Rhoades (1992), Nolle 

(1995), Berger, Kashyap, and Scalise (1995), and 

Robertson (2001)—have also projected the future 

size and structure of the banking industry. Most of 

these projections are based on linear extrapolations 

from past trends. Although these studies all use 

somewhat different approaches, they all predicted 

a sharp decline in the number of commercial banking organizations through the decade of the 1990s 

and beyond.27 

In the earliest of these papers, Hannan and Rhoades (1992) approached the task of projecting future 

U.S. commercial banking structure by assuming 

that the national trend would follow past responses 

to the relaxation of interstate banking regulations 

at the regional level. Accordingly, the authors 

examined more closely the structural transition to 

interstate branching experienced by the Southeast 

and New England over the period 1980–1989.28 

The authors approximated linear trends for each 

region by calculating an average annual rate of 

change in the number of commercial banking 

organizations for the period studied (and for the 

subperiod 1984–1989). They then assumed that 

the number of commercial banking organizations 

in the nation starting in 1989 would change at the 

rate that had been observed in the two regions. 

This method projected the number of commercial 

banking organizations in the United States to be 

in the range of 5,000 to 6,000 by the year 2010 

(depending on the region and period used). For 

comparative purposes, the authors also based projections on extrapolations from national trends. 

This resulted in a projection of just over 5,000 

commercial banking organizations by 2010. 

In addition to extrapolating from regional and 

national trends, the authors also extrapolated from 

the banking structure observed in the state of California, where intrastate branching had been 

allowed since 1908. The commercial banking 

structure in California, they reasoned, would represent a sort of equilibrium case since the structure 

there had evolved in the absence of branching 

restrictions over a long period of time. In this 

25 See, for example, Hughes, Lang, Mester, Moon, and Pagano (2003), Bliss
 

and Rosen (2001), and Gorton and Rosen (1995).
 

26 Support for the too-big-to-fail motive is found in Shull and Hanweck (2001),
 

Penas and Unal (2004), and Kane (2000). Studies on systemic risk include
 

De Nicola and Kwast (2002) and Saunders and Wilson (1999).
 

27 To the best of our knowledge, all previous studies excluded thrift
 

organizations and projected only the numbers of commercial banking
 

organizations or institutions.
 

28 Nolle (1995) reports that by 1984, most of the six New England states had
 

established reciprocal arrangements allowing bank holding companies to own
 

(typically through acquisition) banking subsidiaries in another New England
 

state; by 1987, all six states were participating in these arrangements.
 

Similarly, by 1985 most of the states in the southeastern region of the
 

country had accepted reciprocal arrangements, and by 1988 all of them had.
 

2005, VOLUME 17, NO. 4 42 FDIC BANKING REVIEW 
Consolidation in the U.S. Banking Industry 

extrapolation, the authors assumed that once all 

geographic restrictions on branching were lifted, 

the ratio of commercial banking organizations to 

bank deposits nationwide would approach the ratio 

already observed in California. Projections to 

2010 based on this approach varied depending on 

the period used to formulate the trend. However, 

according to the authors the most realistic projection indicated that the U.S. banking industry 

would eventually shrink to about 3,500 commercial banking organizations.29 

Given the range of predictions yielded by the different cases, Hannan and Rhoades eventually 

offered a “best-guess” projection for the year 2010 

of 5,500 commercial banking organizations. 

Regardless of methodology, however, all extrapolations suggested that, even with a continuation of 

the decline, the long-run equilibrium banking 

structure in the United States would probably consist of a very large number of banking organizations. 

Nolle’s 1995 paper likewise attempted to simulate 

the possible effects on the U.S. banking structure 

of liberalizing interstate branching restrictions. 

Using data on the state-by-state pattern of mergers, 

failures, and entries over the seven-year period 

1987–1993, Nolle mechanically projected the 

number of commercial banks (individually chartered institutions) through the end of the year 

2000. He considered two scenarios: an extrapolation from past trends under the assumption that 

legislation allowing nationwide interstate branching would not be enacted, and a judgmental 

adjustment of the first scenario assuming that 

interstate branching legislation would be passed in 

1994 and fully enacted by midyear 1997 (this latter 

scenario proved to be historically accurate).30 

Results from the first scenario (the no-interstatebranching case) indicated a decrease of just under 

2,100 banks (to 8,798 institutions) during the period 1994–2000—a decrease equal to about twothirds of the amount of consolidation observed 

over the 1987–1993 period. The second extrapolation (the interstate-branching case) suggested 

that the total additional effect on consolidation of 

interstate branching would be an additional 

decline of about 1,000 banks (resulting in an 

industry total of 7,787 commercial banks in the 

year 2000). Given these results, Nolle concluded 

that interstate branching would not fundamentally 

alter the structure of the nation’s commercial 

banking industry; that is, there would still be thousands of commercial banks and thousands of bank 

holding companies in existence at the turn of the 

millennium. 

A conclusion similar to those reached by Rhoades 

and Hannan (1992) and Nolle (1995) was reached 

by Berger, Kashyap, and Scalise (BKS, 1995) as 

well, but they used a much more complex methodology. To quantify the possible effects of the 

removal of all state and federal restrictions on 

interstate branch banking, BKS constructed an 

econometric model to explain the distribution of 

domestic commercial bank assets across organization size classes on a state-by-state basis. In their 

model, the proportion of banking assets in each 

size class was assumed to be a function of state 

demographic variables as well as of a number of 

independent variables that had been designed to 

capture differences in the existence and the lifting 

of regulatory restrictions on statewide and interstate branching as well as on multibank holding 

company acquisitions. 

Using the regressions, BKS then simulated the 

effects of nationwide interstate banking for 5 years, 

10 years, 25 years, and the long term, under two 

scenarios: first, assuming zero growth of gross 

domestic banking assets; second, assuming asset 

growth at the national trend rate over the sample 

period (1979–1994). For each scenario the 

authors assumed that nationwide banking occurred 

29 Extrapolations from the 1980–1989 period actually predicted a slight 

increase in the number of commercial banking organizations nationwide. The 

estimate of 3,500 organizations is based on the trend from 1984 to 1989. 

30 For his interstate branching scenario, Nolle assumed that no states would 

choose to opt out of interstate banking or branching provisions; that all 

multistate, multibank holding companies (MSMBHCs) in existence at midyear 

1993 would still be in existence at midyear 1997, when interstate branching 

was assumed to be fully in effect; and that as a group these MSMBHCs 

would “branch up” 75 percent of their out-of-home-state subsidiary banks by 

year-end 2000. 

FDIC BANKING REVIEW 43 2005, VOLUME 17, NO. 4 
Consolidation in the U.S. Banking Industry 

immediately (in 1994); they therefore removed all 

variation among the explanatory variables related 

to the liberalization of geographic restrictions, 

except for variables capturing time-since-liberalization effects. These time-effect variables were 

adjusted for the number of years to be projected in 

the simulation. The changes in the predicted proportions for each size class for each state were then 

added to the actual proportions in 1994 to obtain 

the future value. The predicted shares of domestic 

banking assets for each size class were then aggregated across the 50 states to obtain a weighted 

average proportion of assets in each size class at the 

national level. Finally, BKS obtained an estimate 

of the number of commercial banking organizations in each size class by dividing the projected 

total dollar value of assets in each size class by the 

average size of organizations in that size class in 

1994. 

Results from the zero-growth simulations indicated 

that “the removal of all geographic barriers to 

nationwide banking was likely to result in continued substantial consolidation of the banking industry.”31 Specifically, in this scenario the model 

predicted that the number of commercial banking 

organizations would fall by almost 4,000 by 1999, 

from a total of 7,926 to 4,106—a decline of almost 

50 percent over five years. Surprisingly, little 

change was predicted to occur after 1999. When 

gross domestic assets were allowed to grow at trend 

rates, the predicted increase in consolidation in 

the first five years due to enactment of interstate 

branching was even greater: the number of commercial banking organizations falls to 3,440. In 

contrast to the zero-growth simulation—which 

predicted little consolidation after the first five 

years—the growth simulation projected the number of organizations as continuing to fall. Under 

this scenario the number of banking organizations 

falls to 1,939 in 25 years—a decline of 76 percent 

from 1994 levels. Notwithstanding these reductions, BKS’s simulations still predicted that the 

banking structure in the United States would be 

characterized by thousands of small banking organizations. This finding was consistent with the findings of Hannan and Rhoades (1992) and Nolle 

(1995). 

Finally, Robertson (2001) projected the number of 

commercial banking organizations in each size 

class by first calculating a transition matrix that 

indicated the probability that a bank would remain 

in the same size class from one year to the next, 

move to a new size class, or leave the industry altogether. After confirming matrix stability, he then 

applied the transition probabilities from the 

1994–2000 transition matrix to the year-end 2000 

numbers to obtain estimates for the industry’s 

future size distribution. On the basis of this 

methodology, Robertson predicted that the number of commercial banking organizations would 

continue to decline—from 6,750 in 2000 to 4,567 

in 2007, for a 32 percent reduction. Like the projections of earlier studies, Robertson’s suggested 

that the number of smaller banking organizations 

would continue to fall steadily. Indeed, Robertson’s simulation predicted that the number of 

banking organizations with less than $100 million 

in real assets would decline by nearly 40 percent 

over the seven-year period he was forecasting. 

New Linear Extrapolations: A Comparison 

with the Literature 

On the basis of earlier studies, then, it seems that 

we can expect to see further declines in the number of banking organizations, especially in the 

community banking sector (where the number of 

organizations with less than $100 million in assets 

is expected to continue to fall dramatically). Some 

of the aforementioned projections, however, are 

based on data that are more than a decade old. 

We show above that the decline in the number of 

banking organizations, while ongoing, has slowed 

appreciably in the last few years. This slowing 

should have important implications for expectations about the future structure of the banking 

industry. Consequently, we have formulated new 

projections of industry structure based on the latest 

observed trends. 

As a starting point, we adhered to the linear 

approach to project the number of banking organizations in each of five size classes through the year 

31 Berger, Kashyap, and Scalise (1995), 113. 

2005, VOLUME 17, NO. 4 44 FDIC BANKING REVIEW 
Consolidation in the U.S. Banking Industry 

Table 1 

Projected Number of Banking Organizations, 2003–2013 

By GDP-Deflated Asset Class 

$100M < $500M < $1B < 

Number of Assets Assets Assets Assets Assets 

Organizations < $100M < $500M < $1B < $10B > $10B Total 

Panel A. Commercial Banks and Thrifts Combined 

5-Year Average 

Quarterly Change –50.55 7.85 5.15 2.50 1.00 

2003 3,683 3,172 481 411 95 

2008 2,672 3,329 584 461 115 

2013 1,661 3,486 687 511 135 

Panel B. Commercial Bank Organizations Only 

5-Year Average 

Quarterly Change –43.40 13.50 3.90 2.70 0.60 

2003 3,219 2,568 335 290 71 

2008 2,351 2,838 413 344 83 

2013 1,483 3,108 491 398 95 

–34.05 

7,842 

7,161 

6,480 

–22.70 

6,483 

6,029 

5,575 

Note: Linear projections based on 5-Year average quarterly change (1999-2003) 

2013. Our projections are based on the 

average quarterly net change over the fiveyear period 1999–2003. We chose to focus 

on only the last five years of data because 

we believe that the change occurring over 

this period better reflects the mix of forces 

affecting the banking industry at the turn 

of the millennium and that this period is 

therefore most relevant to anticipating the 

future direction of the industry’s structure. 

To make our projections comparable with 

those of earlier studies, we projected both 

the number of commercial bank organizations and the number of commercial bank 

and thrift organizations combined. Table 

1 presents our five- and ten-year projections. As can be seen in panel A, our linear extrapolations suggest a continuing 

decline (of 34 organizations per quarter) in 

the total number of banking and thrift 

organizations—from 7,842 at year-end 

2003 to 7,161 at year-end 2008 and to 

6,480 at the end of 2013. The projected 

decline over five years is 681 organizations 

(8.7 percent); over ten years, twice that. 

Projections for commercial bank organizations alone (panel B) show a similar pattern. Interestingly, projections for both 

groups indicate that the decline will occur 

exclusively within the smallest size group (organizations 

with less than $100 million in assets). Our extrapolations 

from the trends of the past five years indicate that all other 

size groups will grow by small amounts. 

For comparison, figure 12 contrasts our linear projections 

for the number of commercial bank organizations with 

those from earlier studies. Remarkably, Hannan and 

Rhoades’s (1992) “best-guess” 20-year projection for the 

number of commercial bank organizations in 2010 is not 

that much different from our own—their 5,500 compared 

Figure 12 

Comparison of Projections for the Commercial Bank
 

Organizations, 1984–2013
 

Number of Organizations 

14,000 

12,000 

10,000 

8,000 

6,000 

4,000 

2,000 

0 

Dec Dec Dec Dec Dec Dec Dec Dec Dec Dec Dec Dec Dec Dec Dec 

84 86 88 90 92 94 96 98 00 02 04 06 08 10 

Year 

Historical Projected 

Hannan&Rhoades (1992) 

Jones/Critchfield 

BKS (1995) 

Robertson (2001) 

FDIC BANKING REVIEW 45 2005, VOLUME 17, NO. 4 

13 
 

Consolidation in the U.S. Banking Industry 

with our 5,847. The projections by BKS (1995) 

and Robertson (2001), however, suggest significantly more of a decline among commercial bank 

organizations than is indicated by our linear 

extrapolation from the data for the last five years. 

Beyond Linear Extrapolations 

Although linear extrapolations like those described 

above provide a simple means of projecting industry structure, Shull and Hanweck (2001) have 

argued that projections based on simple linear 

extrapolations of past trends are inadequate 

because they fail to specify the process generating 

the structural change. We tend to agree. 

Although we used the linear approach for illustrative purposes, we believe this approach is somewhat naive because it fails to incorporate all the 

information contained in the data. Most importantly, it ignores the changing nature of the forces 

behind the decline in the number of organizations. 

Consequently, for reasons that will soon become 

clear, we view our linear projections as representing the lower bound of our estimates of the future 

size of the banking industry. 

To improve on the simple linear extrapolations 

presented above, what is needed is a forecasting 

methodology that can capture the underlying features of the full time series on banking structure. 

An extremely general econometric model that 

promises to do this in a simple and expeditious 

manner is the autoregressive integrated moving 

average time-series model (ARIMA). First developed by Box and Jenkins (1976), this approach to 

modeling the processes that generate a time series 

of data has “withstood the test of time and experimentation as a reasonable approach for describing 

underlying processes that are probably, in truth, 

impenetrably complex.”32 In simple descriptive 

terms, this class of models either regresses a time 

series on its own past values or uses a moving average process to express a times series as a linear 

combination of past error terms, or does both. In 

practice, the Box-Jenkins approach to time-series 

model building has been made relatively easy 

through the use of modern statistical software programs. After testing various models for fit, we 

selected for our forecasting a first-order moving 

average model, fit to the second-differenced log of 

the time series.33 

Figure 13 illustrates our forecasts of the total number of banking organizations for the years 

2004–2013, based on the estimated parameters of 

our time-series model. As can be seen, we project 

the consolidation trend in the banking industry as 

continuing over the next ten years, albeit at a 

slightly slower pace over the second five-year period. In the near term (the next five years), according to our model, the industry will decline by a 

total of 552 organizations, from 7,842 at year-end 

2003 to 7,290 by the end of 2008 (a decline of 7 

percent). By 2013, our forecast shows the banking 

industry shrinking by an additional 424 organizations, to 6,866 (a 6 percent decline)—for a total 

reduction of almost a thousand organizations (or 

slightly more than 12 percent) over the ten-year 

period. 

Although we believe that the forecast based on our 

moving average model is a substantive improvement over the forecast obtained through the simple linear extrapolation method, another 

interpretation of the data suggests that consolidation of the industry is slowing more appreciably 

than is suggested even by our time-series forecast. 

Indeed, according to an interpretation presented 

by Shull and Hanweck (2001), the decades-long 

consolidation trend in banking may come to an 

end in the not-too-distant future. Basically, Shull 

and Hanweck view the structural change in banking as a dynamic and nonlinear process in which a 

32 Greene (2000), 531. 

33 Given a time series, one can estimate several types of models within the 

class of ARIMA models. Model selection can then be based on the use of 

information criteria such as Akaike’s information criterion (AIC) or Schwarz’s 

Bayesian criterion (SBC), which seek to identify the “best” model—best in 

terms of accuracy and efficiency. We chose to use the SBC because of its 

greater emphasis on parsimony. Among the models tested, we settled on a 

first-order moving average model where the model was fit to the seconddifferenced log of the time series using maximum likelihood estimation 

(ARIMA [0,2,1]). Second-differencing was needed to achieve stationarity—an 

important underlying assumption of model estimation. To confirm stationarity, 

we examined the autocorrelation and partial correlation functions and 

conducted a Dickey-Fuller unit root test. See Box, Jenkins, and Reinsel 

(2000) or Judge et al. (1988) for a more detailed explanation of time-series 

model estimation and fit. Further details on model selection and testing are 

available from the authors of the present study. 

2005, VOLUME 17, NO. 4 46 FDIC BANKING REVIEW 
Consolidation in the U.S. Banking Industry 

population of banks in a stable state has been subjected to 

an exogenous shock (or shocks) that causes the population 

to shift to a new steady-state equilibrium. According to 

this interpretation, the reduction in the number of banking 

organizations is characterized as a situation in which an 

equilibrium banking structure (described by the stability in 

the number of banking organizations in the United States 

before 1980) was disturbed by economic, regulatory, and 

technological changes. The consequent decline reflected a 

transitional movement toward a new equilibrium structure. 

Figure 13 

Projected Number of Thrift and Commercial Bank 

Organizations, 1984–2013 

Number of Organizations 

0 

2,000 

4,000 

6,000 

8,000 

10,000 

12,000 

14,000 

6,866 

7,842 

Historical Projected 16,000 

7,161 

6,480 

ARIMA Forecast 

Linear Forecast 

2008 

7,290 

Mar Mar Mar Mar Mar Mar Mar Mar Mar Mar Mar Mar Mar Mar Mar 

84 86 88 90 92 94 96 98 00 02 04 06 08 10 13 

Year 

Figure 14 

y = 8E-10x2 - 2E-05x + 0.0859 

R 2

 = 0.5645 

-2.00 

-1.50 

-1.00 

-0.50 

0.00 

0.50 

15,000 14,000 13,000 12,000 11,000 10,000 9,000 8,000

Number of Organizations 

1984 1988 1992 1996 2000 

Quarterly Rate of Change (Percentage) 

Year 

Trend Line 

Phase Diagram of Number of Commercial Bank and 

Thrift Organizations, 1984–2003 

Figure 14 follows Shull and Hanweck in 

using a phase diagram. It plots the quarterly rate of change in the number of 

banking organizations against the actual 

number of organizations for the period 

1984–2003. In the diagram we can 

observe a distinct transitional pattern (as 

indicated by the trend ine) from an equilibrium structure of just over 15,000 

organizations (when the rate of change 

was last near zero) to the current structure 

of just under 8,000 organizations (at yearend 2003). Indeed, the transitional 

nature of the plot is quite dramatic. One 

noteworthy feature of the diagram is that 

once the numbers of banking organizations began to decline, they did so first at 

an increasing rate and then at a decreasing rate. The turning point appears to 

have been at about 11,500 organizations. 

This is roughly the size of the industry in 

mid-1992. Interestingly, that year marked 

both the end of a national recession and 

the unofficial end of the S&L and banking crises. And if we layer the phase diagram with a time line, it becomes easy to 

see how the transition has progressed 

since 1984. 

Extension of the trend line to a point of 

intersection with the zero-rate-of-change 

line would indicate that the structure of 

the banking industry will again reach an 

equilibrium structure in about five years, 

at approximately 7,250 organizations 

(assuming that progression along the 

trend proceeds unimpeded). The conclusion to be drawn from the phase diagram—that the decline in the number of 

banking organizations has slowed appreciably and that industry structure is likely 

to stabilize within the next few years at 

about 7,250 organizations—is at least 

numerically consistent with the five-year 

forecast generated by our moving average 

model. 

FDIC BANKING REVIEW 47 2005, VOLUME 17, NO. 4 
Consolidation in the U.S. Banking Industry 

Conclusion 

Considered together, our three forecasts (based on 

linear extrapolation, time-series modeling, and a 

phase diagram) imply that in the absence of a new 

shock to the industry, the U.S. banking industry is 

likely to retain a structure characterized by several 

thousand very small to medium-size community 

bank organizations, a less-numerous group of midsize regional organizations, and a handful of 

extremely large multinational banking organizations. Consistent with projections from earlier 

studies, our projections indicate that the U.S. 

banking industry is not likely to resemble the 

banking industries in countries such as Germany, 

which have only a handful of universal banks. 

Although our forecasts contrast rather sharply with 

conventional wisdom about the future pace of 

decline in the number of banking institutions, we 

believe these projections to be reasonable under 

current conditions. The major influences of the 

1980s, under which the decline accelerated, are no 

longer relevant. Gone are the high failure rates 

and other contractionary influences of the thrift 

and banking crises. Similarly, the effects of the liberalization of interstate banking and branching 

laws are largely in the past, as are the effects of 

most other major deregulatory initiatives. Bank 

holding companies, for example, have already collapsed inefficient multistate, multibank structures, 

and opportunities for additional gains are limited. 

This might be especially true for the larger banks 

(which have been particularly active merger participants) as they become increasingly constrained 

by state and federal limits on deposit market 

shares. Also gone are the merger-accommodating 

atmosphere and the “irrational exuberance” that 

accompanied the amazing stock market boom of 

the late 1990s. 

In their place is a more uncertain economic environment that has spawned fewer bank mergers and 

consolidations. Although we believe that sustained industry profitability and competitive pressures will lead to some additional decline in the 

number of banking organizations going forward, we 

do not foresee a return to the rate of decline witnessed in the late 1980s and early 1990s. Rather, 

we see a balance developing between the number 

of bank start-ups and the number of charter losses 

due to mergers and acquisitions—with little net 

change in the number of banking organizations 

nationwide. In other words, it just might be that 

the consolidation trend in banking—that “long, 

strange trip”—is nearing an end. 

2005, VOLUME 17, NO. 4 48 FDIC BANKING REVIEW 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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FDIC BANKING REVIEW 53 2005, VOLUME 17, NO. 4 
Consolidation in the U.S. Banking Industry 

Table A1 

Share of Industry Assets and Deposits Held by the Nation's 25 Largest Banking Companies 

(Pro-forma) Data as of December 31, 2003 

Share of 

Total Share of Cumulative Domestic Industry Cumulative 

Assetsa Industry Percentage Deposits Domestic Percentage 

Ranking Bank Holding Company ($ Billions) Assets of Assets ($ Billions) Deposits of Deposits 

1 J.P. Morgan Chase & Co. / Bank Oneb 1,009 11.11 11.11 345 6.61 6.61 

2 Bank of America / Fleetbostonb 870 9.58 20.70 512 9.82 16.43 

3 Citigroup Inc. 796 8.77 29.47 181 3.47 19.90 

4 Wells Fargo & Company 380 4.19 33.65 241 4.62 24.52 

5 Wachovia Corporation 362 3.99 37.65 213 4.09 28.61 

6 Washington Mutual Inc. 276 3.04 40.68 168 3.23 31.84 

7 U.S. Bancorp 192 2.12 42.80 114 2.19 34.03 

8 National City Corporation 132 1.45 44.26 61 1.17 35.20 

9 Suntrust Banks, Inc. 125 1.37 45.63 76 1.47 36.67 

10 ABN AMRO Holding N.V. 107 1.18 46.81 46 0.88 37.55 

11 HSBC Holdings PLC 98 1.08 47.88 45 0.86 38.41 

12 Fifth Third Bancorp 95 1.05 48.93 51 0.97 39.38 

13 BB&T Corporation 95 1.04 49.97 60 1.16 40.54 

14 The Bank of New York Company, Inc. 90 0.99 50.97 34 0.65 41.19 

15 Keycorp 85 0.93 51.90 48 0.92 42.11 

16 State Street Corporation 80 0.89 52.79 13 0.25 42.36 

17 Golden West Financial Corp. 80 0.89 53.67 45 0.87 43.23 

18 The Royal Bank of Scotland Group PLC 78 0.86 54.53 58 1.12 44.34 

19 The PNC Financial Services Group, Inc. 64 0.71 55.24 45 0.87 45.21 

20 MBNA Corporation 59 0.64 55.89 31 0.59 45.80 

21 COMERICA Incorporated 53 0.58 56.47 40 0.78 46.58 

22 Southtrust Corporation 52 0.57 57.04 33 0.62 47.21 

23 Allied Irish Banks, P.L.C. 50 0.55 57.59 31 0.59 47.80 

24 Mitsubishi Tokyo Financial Group, Inc. 48 0.53 58.12 35 0.67 48.47 

25 AMSOUTH Bancorporation 46 0.50 58.62 29 0.56 49.03 

Total Top 25 Banking Companies $5,321 58.62 $2,556 49.03 

a Non-bank assets are excluded. 

b Pro-forma data include two pending mergers: Bank of America and Fleetboston, J.P. Morgan Chase & Co. and Bank One Corp. 

Source: FDIC Call Reports and Thrift Financial Reports 

2005, VOLUME 17, NO. 4 54 FDIC BANKING REVIEW 
Consolidation in the U.S. Banking Industry 

Table A2 

Major Legislative and Regulatory Changes Affecting Banking Consolidation 

Year Description 

1980 Depository Institutions Deregulation and Monetary Control Act (DIDMCA). Raised federal deposit insurance coverage 

limit from $40,000 to $100,000. Phased out interest-rate ceilings. Allowed depositories to offer negotiable order of 

withdrawal (NOW) accounts nationwide. Eliminated usury ceilings. Imposed uniform reserve requirements on all 

depository institutions and gave them access to Federal Reserve services. 

1982 Garn-St Germain Act. Permitted money market deposit accounts. Permitted banks to purchase failing banks and thrifts 

across state lines. Expanded thrift lending powers. 

1987 Competitive Equality in Banking Act (CEBA). Allocated $10.8 billion in additional funding to the Federal Savings and 

Loan Insurance Corporation (FSLIC). Authorized forbearance program for farm banks. Reaffirmed that the "full faith 

and credit" of the U.S. Department of the Treasury (Treasury) stood behind federal deposit insurance. 

1987 Board of Governors of the Federal Reserve System (Federal Reserve) authorized limited underwriting activities for 

Bankers Trust, J.P. Morgan, and Citicorp with a 5 percent revenue limit on Section 20 ineligible securities activities. 

1989 Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA). Provided $50 billion in taxpayer funds to 

resolve failed thrifts. Replaced Federal Home Loan Bank Board with the Office of Thrift Supervision to charter, 

regulate and supervise thrifts. Restructured federal deposit insurance for thrifts and raised premiums. Re-imposed 

restrictions on thrift lending activities. Directed the Treasury to study deposit insurance reform. 

1989 Federal Reserve expanded Section 20 underwriting permissibility to corporate debt and equity securities, subject to 

revenue limit. 

1989 Federal Reserve raised limit on revenue from Section 20 eligible securities activities from 5 percent to 10 percent. 

1991 Federal Deposit Insurance Corporation Improvement Act (FDICIA). Directed the Federal Deposit Insurance Corporation 

(FDIC) to develop and implement risk-based deposit insurance pricing. Required "prompt corrective action" of poorly 

capitalized banks and thrifts and restricted "too big to fail." Directed the FDIC to resolve failed banks and thrifts in 

the least costly way to the deposit insurance funds. 

1993 Court ruling in Independent Insurance Agents of America v. Ludwig allowed national banks to sell insurance from small 

towns. 

1994 Riegle-Neal Interstate Banking and Branching Efficiency Act (Riegle-Neal). Permitted banks and bank holding companies 

(BHCs) to purchase banks or establish subsidiary banks in any state nationwide. Permitted national banks to open 

branches or convert subsidiary banks into branches across states lines. 

1995 Court ruling in NationsBank v. Valic allowed banks to sell annuities. 

1996 Court ruling in Barnett Bank v. Nelson overturned states' restrictions on bank insurance sales. 

1996 Federal Reserve announced the elimination of many firewalls between bank and nonbank subsidiaries within BHCs. 

1996 Federal Reserve raised limit on revenue from Section 20 eligible securities activities from 10 percent to 25 percent. 

1997 Federal Reserve eliminated many of the remaining firewalls between bank and nonbank subsidiaries within BHCs. 

1999 Gramm-Leach-Bliley Financial Modernization Act (GLB). Authorized financial holding companies (FHCs) to engage in a 

full range of financial services such as commercial banking, insurance, securities, and merchant banking. Gave the 

Federal Reserve, in consultation with the Treasury, discretion to authorize new financial activities for FHCs. Gave the 

Federal Reserve discretion to authorize complementary actives for FHCs. Established the Federal Reserve as the 

"umbrella" regulator of FHCs. Provided low-cost credit to community banks. Reformed the Community Reinvestment 

Act. Eliminated the ability of commercial firms to acquire or charter a single thrift in a unitary thrift holding company. 

2001 Federal Reserve issued revisions to Regulation K. Expanded permissible activities abroad for U.S. banking organizations. 

Reduced regulatory burden for U.S. banks operating abroad and streamlined the application and notice process for 

foreign banks operating in the United States. Allowed banks to invest up to 20 percent of capital and surplus in 

Edge Corporations. Liberalized provisions regarding the qualification of foreign organizations for exemptions from the 

nonbanking prohibitions of Section 4 of the Bank Holding Company Act. Implemented provisions of Riegle-Neal that 

affect foreign banks. 

Sources: Lown, Osler, Strahan, and Sufi (2000); Kroszner and Strahan (2000); and Montgomery (2003). 

FDIC BANKING REVIEW 55 2005, VOLUME 17, NO. 4 
Consolidation in the U.S. Banking Industry 

Table A3 

Summary of Recent Empirical Studies on the Causes of Consolidation in the Banking Industry 

Empirical Finding Study Reference Summary 

Some evidence of increase in Shull and Hanweck (2001); Berger, Demsetz, and Surveyed the literature and found evidence of 

market power (share) with Strahan (1999) market power effects (with higher loan rates and 

some evidence of price lower deposit rates in concentrated markets) in the 

effects in concentrated market 1980s. Data for the 1990s, however, suggested a 

weaker relationship between local market 

concentration and deposit rates. 

Pilloff (1999) Found that banks in more concentrated markets 

earned higher profits and that the number of 

multimarket contacts was positively related to 

profitability-suggesting that multimarket contact 

may reduce competition. 

Prager and Hannan (1998) Found that a reduction in interest rates on local 

deposit accounts was associated with horizontal 

mergers that raised market concentration 

significantly. 

Simons and Stavins (1998) Using data for the period 1986-1994, found that 

after a bank's participation in a merger, a 1.0 

percent higher HHI was associated with a 1.2 

percent reduction in interest rates on MMDA, a 0.3 

percent lower rate on CDs, and lower rates on 

deposit accounts across the board. 

Moore and Siems (1998) Found that the relationship between concentration 

and profitability was much weaker in 1997 than it 

had been a decade earlier. 

Berger and Hannan (1997) Found that banks in more concentrated markets 

charged higher rates on small business loans and 

paid lower rates on retail deposits. 

Some evidence of greater Berger (1998); Akhavein, Berger, and Humphrey Found that mergers led to an improvement in profit 

profit efficiencies (1997) efficiency. The improvement seemed to result from 

an increase in lending activity (as opposed to 

security investments) and a more efficient use of 

capital. 

Boyd and Graham (1998) Found that being merged "helped" small banksincreasing ROA and decreasing expense measures. 

Some evidence of Group of Ten (2001) Reviewed the latest research, which suggested that 

improvements from because of geographic diversification, consolidation 

geographic diversity of banks within the United States was likely to 

lead to reductions in risk. However, the studies 

also noted that these positive benefits might be 

offset by shifts to higher-risk portfolios or by 

operational risks. 

2005, VOLUME 17, NO. 4 56 FDIC BANKING REVIEW 
Consolidation in the U.S. Banking Industry 

Table A3 continued 

Summary of Recent Empirical Studies on the Causes of Consolidation in the Banking Industry 

Empirical Finding Study Reference Summary 

Some evidence of Berger and DeYoung (2001) Found that the negative effects of distance tended 

improvements from to be modest in size. This finding suggests that 

geographic diversity efficient organizations can successfully export their 

superior skills, policies, and practices to their outof-state affiliates. 

Hughes, Lang, Mester, and Moon (1996, 1999) Found that when organizations diversified 

geographically, especially via interstate banking, 

efficiency tended to be higher and insolvency risk 

tended to be lower. 

Some evidence of Hancock, Humphrey, and Wilcox (1999) Found substantial scale economies in Fedwire 

improvements in payment operations and an improvement in cost efficiency 

system efficiency of Fedwire from consolidation of processing sites. 

Suggested results were likely to carry over to 

consolidation of private sector processors. 

Adams, Bauer, and Sickles (2002) Found indications of significant and positive scale 

economies in the provision of electronic payment 

processing services by the Federal Reserve 

(Fedwire, ACH, and Book-Entry securities). Results 

also showed that during the 1990s, technological 

change lowered marginal costs significantly. 

Some evidence that Hughes, Lang, Mester, Moon, and Pagano (2003) Found evidence that managerial entrenchment at 

management may act in self- U.S. bank holding companies was associated with 

interest asset sales that yielded smaller improvements and 

with acquisitions that resulted in worse 

performance. Suggested that these results were 

consistent with empire-building strategies that 

sacrificed value. 

Bliss and Rosen (2001); Gorton and Rosen (1995) Argued that two primary motives for bank mergers 

were empire building and increased managerial 

compensation, especially on the part of managers 

who were entrenched or insulated from the market. 

Hadlock, Houston, and Ryngaert (1999) Found that banks with higher levels of 

management ownership were less likely to be 

acquired; argued that this evidence was consistent 

with an entrenchment hypothesis, which holds that 

management teams with significant ownership 

positions block attempts to be acquired at 

reasonable prices. 

FDIC BANKING REVIEW 57 2005, VOLUME 17, NO. 4 
Consolidation in the U.S. Banking Industry 

Table A3 continued 

Summary of Recent Empirical Studies on the Causes of Consolidation in the Banking Industry 

Empirical Finding Study Reference Summary 

Some support for the too-big- Shull and Hanweck (2001) Found that the top 10 largest banks paid less for 

to-fail motive funds than smaller banks and operated with lower 

capitalization rates. 

Penas and Unal (2004) Showed that positive bond returns and a decline in 

credit spreads were related to the incremental size 

attained in bank mergers by medium-sized banksthose most likely to become large enough to be 

considered TBTF. 

Kane (2000) Showed that in banking megamergers of 1991-98, 

stockholders of large-bank acquirers gained value 

when a target institution was large. Argued that 

the effect of size underscored the possibility that 

too-big-to-discipline subsidies had distorted dealmaking incentives for megabanks. 

Some potential for increased De Nicola and Kwast (2002) Showed that, among large complex banking 

systemic risk and safety net organizations during the 1990s, there was a 

expansion significant upward trend in the degree of 

interdependency. 

Group of Ten (2001) Concluded that there were reasons to believe that 

financial consolidation in the United States had 

increased the risk that the failure of a large 

complex banking organization would be disorderly. 

Saunders and Wilson (1999) Found a dramatic reduction in bank capital ratios 

associated with increased safety-net support; also 

found that the structure and strength of safety-net 

guarantees might affect risk taking. 

2005, VOLUME 17, NO. 4 58 FDIC BANKING REVIEW 
Consolidation in the U.S. Banking Industry 

Table A3 continued 

Summary of Recent Empirical Studies on the Causes of Consolidation in the Banking Industry 

Empirical Finding Study Reference Summary 

BUT Stiroh (2000) Examined the improved performance of U.S. BHCs 

Mixed evidence on cost from 1991 to 1997 and found that the gains were 

efficiencies from scale due primarily to productivity growth and changes 

economies in scale economies. Estimated cost functions 

showed modest economies of scale present 

throughout the period, with the largest BHCs 

showing stronger economies of scale. 

Hughes, Mester, and Moon (2001); Hughes, Lang, Claimed to have found evidence of large-scale 

Mester, and Moon (1999); Hughes and Mester economies once risk diversification, capital 

(1998) structure, and endogenous risk taking were 

explicitly considered in the analyses of production. 

Berger, Demsetz, and Strahan (1999) Extensively reviewed the literature on cost 

efficiency and found-on the basis of data from the 

1980s and early 1990s-little efficiency improvement 

from mergers and acquisitions. However, cost 

efficiency effects might depend on the type of 

merger, the motivations of the managers, and the 

implementation of the merger. 

Kwan and Wilcox (1999) Found significant (but still relatively small) expense 

savings in mergers that occurred in the mid-1990s, 

after the pure accounting effects on reported 

expense data were removed. 

Boyd and Graham (1998) Examined the effects of mergers and found 

evidence of cost efficiency gains for only the 

smallest banks. The gains disappeared quickly 

with increases in size and were negative for larger 

banks. 

Peristiani (1997) Found that acquiring banks in the 1980s achieved 

moderate improvements in scale efficiencyattributable in part to the fact that the smaller 

target banks were on average less scale-efficient 

than their acquirers. 

Mixed evidence on cost Stiroh (2004) Examined the link between the banking industry's 

efficiencies from scope growing reliance on noninterest income and the 

economies volatility of bank revenue and profits. Found 

almost no evidence that this shift offers large 

diversification benefits in the form of more stable 

profits or revenue. 

Amel et al. (2002) In reviewing the literature, found little evidence 

that mergers yielded significant economies of 

scope. 

FDIC BANKING REVIEW 59 2005, VOLUME 17, NO. 4 
Consolidation in the U.S. Banking Industry 

Table A3 continued 

Summary of Recent Empirical Studies on the Causes of Consolidation in the Banking Industry 

Empirical Finding Study Reference Summary 

Mixed evidence on cost DeLong (2001) Found that mergers that focused banks 

efficiencies from scope geographically and among product types created 

economies (cont.) value, whereas those that diversified generally 

failed to benefit shareholders. 

Demsetz and Strahan (1997) Showed that large bank-holding companies had 

better diversification across loan portfolios; it 

allowed them to operate with greater leverage and 

engage in more risky (and potentially more 

profitable) lending without increasing firm-specific 

risk. 

Kwan (1998) Found that securities subsidiaries provided BHCs in 

the United States with potential benefits of 

diversification because revenues from the 

subsidiaries were not highly correlated with 

revenues from the rest of the BHC. 

Berger, Humphrey, and Pulley (1996) Found no evidence of statistically significant 

revenue economies (and only small cost economies) 

of scope among either small or large banks over 

the period 1978-1990, even for the most efficient 

banks. 

Little evidence of any Calomiris and Karceski (1998); Pilloff and Reviewed the literature and concluded that 

significant, permanent Santomero (1998) although some event studies found that acquirers 

increase in shareholder value increased their market value, most studies found 

that the market value of the acquiring bank 

declined whereas that of the target bank increased. 

Houston, James, and Ryngaert (2001) Found (like previous studies) that the market value 

of the acquiring bank declined, on average, 

whereas that of the target bank increased. 

However, compared with the 1980s, the 1990s 

were a period of higher average abnormal returns 

for both bidders and targets. Results also 

suggested that the realization of anticipated cost 

savings was the primary source of gains in the 

majority of recent bank mergers. 

Cornett et al. (2003) Found that diversifying bank acquisitions earn 

significantly negative announcement-period 

abnormal returns for bidder banks, whereas 

focusing acquisitions earn zero abnormal returns. 

2005, VOLUME 17, NO. 4 60 FDIC BANKING REVIEW 
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Table A3 continued 

Summary of Recent Empirical Studies on the Causes of Consolidation in the Banking Industry 

Empirical Finding Study Reference Summary 

Little evidence of lower Shull and Hanweck (2001) After reviewing prices for retail banking services 

consumer prices over the last decade, found no evidence that retail 

prices had declined. In fact, the evidence 

suggested the opposite-that consumer prices had 

increased. 

Kahn, Pennachi, Sopranzetti (2000) Found that mergers appeared to increase rates on 

unsecured personal loans charged by all banks in 

the market in which the merger had taken place. 

This was consistent with an increase in market 

power in the market for personal loans. However, 

the opposite effect was observed for rates on 

automobile loans. 

Prager and Hannan (1998) Found a reduction in deposit rates attributable to 

substantial horizontal mergers (mergers between 

banks competing in the same geographic markets). 

Little effect on the availability Avery et al. (1999) Found that mergers of banks with branches in the 

of services to consumers same zip code reduced the number of branches per 

capita, whereas other mergers had little effect on 

branch office availability. 

DeYoung et al. (1998) Found that small business lending declined as 

banks aged and increased in size. But an increase 

in market concentration was found to have a 

positive effect on small business lending in urban 

markets and only a modest negative effect in rural 

markets. 

Jayaratne and Wolken (1999) Found (using survey data on small business 

borrowers) that the probability that a small firm 

would have a line of credit from a bank did not 

decrease in the long run when there were fewer 

small banks in the area. 

Peek and Rosengren (1996, 1998); Strahan and Found that large banking organizations generally 

Weston (1996, 1998); Berger, Kashyap, and Scalise devoted smaller proportions of their assets to small 

(1995) business loans and that mergers between large and 

small banks resulted in a decrease in small 

business lending. Mergers between smaller banks, 

however, did not appear to reduce small business 

lending. 

Cole, Goldberg, and White (2004) Found that large banks tended to base their small 

business loan decisions more on financial ratios 

than on prior lender-borrower relationships. In 

contrast, small banks relied to a greater extent on 

the character of the borrower. 

FDIC BANKING REVIEW 61 2005, VOLUME 17, NO. 4