Working Paper

Regulatory incentives and consolidation: the case of commercial bank mergers and the Community Reinvestment Act

Abstract: Bank regulators are required to consider a bank?s record of providing credit to low- and moderate-income neighborhoods and individuals in approving bank applications for mergers and acquisitions. We test the hypothesis that banks strategically prepare for the regulatory and public scrutiny associated with a merger or acquisition by increasing their lending to low-and moderate-income individuals in anticipation of acquiring another institution. We find evidence in favor of this hypothesis. In particular, we show that the higher the percentage of the institution?s mortgage originations in a given year that are directed to low- and moderate-income individuals or neighborhoods, the greater the probability that the institution will acquire another bank in the following year. Further investigation bolsters the view that this correlation is due to banks? anticipation of the public and regulatory scrutiny during the merger review process. The effect cannot be explained by other bank characteristics. The relationship is observed for acquiring banks, which are the focus of public and regulatory scrutiny, but not for the banks that are being acquired. In addition, the positive effect of lending to low- and moderate-income individuals and neighborhoods on the likelihood that a bank will acquire another bank increases over the 1991 - 1995 time frame, a period when public and regulatory scrutiny of an institution?s community lending record increased. The effect of lending to low- and moderate-income individuals and neighborhoods is also largest for big banks, who face particularly intense public and regulatory scrutiny

Keywords: Bank mergers; Bank supervision; Community Reinvestment Act of 1977;

Bibliographic Information

Provider: Federal Reserve Bank of Chicago

Part of Series: Working Paper Series

Publication Date: 2002

Number: WP-02-06