A Quantitative Model of Bank Merger Dynamics

Abstract: We develop a simple model of the bank merger process to study the rise in bank concentration following the deregulation of bank branching  which resulted from the Riegle-Neal Act of 1994. Motivated by the data -- where currently 4 (dominant) banks have over 40 percent of the U.S. deposit market share while the remaining approximately 4000 (fringe) banks cover the rest-- we apply a dominant-fringe framework with a merger stage to model the rise in concentration following the change in regulation making interstate branching possible.  We study the effect of the merger wave on competition, efficiency, and stability of the banking industry. We focus on the heterogeneous response of big and small banks' lending to idiosyncratic deposit shocks (i.e. their marginal propensity to lend) and how this translates to granularity we document in the banking industry. Further, we examine how the effectiveness of monetary policy varies with rising loan market power.