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September 15, 1985

Federal Reserve Bank of Cleveland

ISSN 0428-1276

ECONOMIC
COMMENTARY
Interstate banking is rapidly becoming a
marketplace reality. The pace of change
is so rapid that 1985 may be a watershed
in eliminating interstate banking barriers.
No state permitted interstate banking until
1975. Today, 27 states allow some type
of out-of-state entry by commercial banks.
Recently, Ohio joined Kentucky and
Indiana in permitting interstate banking.
Ohio has adopted regional reciprocal
interstate banking legislation. In this
Economic Commentary, we examine the
rationale for this approach, summarize the
Ohio legislation, and look at the status of
interstate banking legislation in those
states included in the Ohio legislation.
It appears that a regional banking zone,
as contemplated in Ohio's legislation, is
forming in the Midwest. Thus, it is relevant
to ask how a midwestern banking region
would affect Ohio banks. By comparing
the commercial banking structure in Ohio
with several states included in Ohio's
legislation, we can speculate about the
possible effects of interstate banking on
Ohio banks. Then, by examining the
financial condition of Ohio's largest banking
organizations, we can assess how well
they are positioned to expand into markets
beyond the state's borders.

Thomas M. Buynak is an economist at the Federal
Reserve Bank 0/ Cleveland. Charlotte Taylor and
Steve R uetschi provided research assistance lor
this article. The author would also like to thank
Mark Sniderman and Owen Humpage /01' their
helpful comments.
The views stated herein are those 0/ the author
and not necessarily those 0/ the Federal Reserve
Banh 0/ Cleveland or 0/ the Board 0/ Governors 0/
the Federal Reserve System.

The Popularity of Regional
Interstate Banking
Because Congress has been unable to enact
federal interstate banking legislation, the
states have taken the initiative. Each state
is authorized by the Douglas Amendment
of the Bank Holding Company Act of 1956
to permit entry of out-of-state banks into
its territory. Bank holding companies
(SHCs) can thus cross state lines.
The 27 states authorizing interstate
banking have taken a variety of approaches
that are generally designed to benefit the
state's economy and to protect and enhance
the position of each state's banks and
shareholders. Alaska, Arizona, and
Maine, for example, have the most liberal
laws, allowing unconditional out-of-state
entry; New York allows entry from any
state if that state reciprocates. Other
states, such as Ohio, Kentucky, and
Indiana, allow regional reciprocal interstate banking.
The regional reciprocal pact, which
restricts entry to contiguous states or to
states in a specified region, is the most
popular approach; 15 states have adopted
it. I Banking regions are forming in New
England and in states in the mid-Atlantic
area, the Far West, the Midwest, and
the Southeast.
One objective of the regional approach
is to unite states that have similiar economic
structures. A more important objective,

1. See Ban/ling Expansion Reporter. vol. 4, no. 17
(September 2,1985), pp. 5·7.

Interstate Banking:
Its Impact on
Ohio Banks
by Thomas

M. Buynak

however, may be to protect local banks by
selectively barring entry from certain states,
such as New York, where the large,
money-center banks are headquartered.
While Ohio's largest BHC has approximately $9 billion in deposits, for example,
New York has six banking organizations
whose deposits each exceed $25 billion.
The protection of local banks in regional
banking pacts, however, limits the number
of potential bidders for banks that elect
to become acquirees. From a seller's
view, regional banking yields more bidders
than the status quo - assuming a state
permits BHC expansion on an intrastate
basis, but there would be more potential
bidders if interstate banking were completely unrestricted. This makes the terms
of trade, or the acquisition premium paid
over stock price, for the selling bank
possibly less favorable than if nationwide
banking were permitted.

Ohio's Interstate Banking Legislation
In March 1985, the Ohio House passed
an interstate banking measure. By early
July, in light of a U.S. Supreme Court
ruling upholding the constitutionality
of
selective regional banking pacts, the Ohio
Senate quickly enacted the House bill
with two key amendments. 2 One amendment
shortened the trigger date to nationwide
banking from four years to three years."

2. On June 10, 1985, the U.S. Supreme Court reduced
legal uncertainities
surrounding
the selective
exclusion of states from regional reciprocal pacts.
New England's interstate banking laws were contested,
because New York banks were excluded from the
New England banking region. New York banks
argued that, according to the Douglas Amendment,
a state's only choice in permitting interstate banking
is an ali-or-nothing proposition. The Supreme Court
disagreed.

The other amendment added savings and
loan institutions to the legislation.
Under Ohio's legislation, reciprocity is
extended to commercial banks and to
savings and loan institutions in Michigan,
Indiana, Kentucky, West Virginia,
Pennsylvania, Missouri, Wisconsin, Illinois,
Tennessee, Virginia, Maryland, Delaware,
New Jersey, and the District of Columbia.
The law becomes effective October 17,
1985. It also provides that, after October
16, 1988, Ohio will grant reciprocal entry
to any state on a nationwide basis.
A BHC entering Ohio must have its
principal place of business (that is, 51
percent of its deposits) in an authorized
reciprocating state. This prevents excluded
banking organizations from entering Ohio
through what is referred to as leapfrogging.
To illustrate: assume that an out-of-state
acquisition of an Ohio bank is legal initially
(e.g., a Kentucky BHC acquires an Ohio
bank). Now assume that the BHC is subsequently acquired itself by another BHC
in an unauthorized state, say a New York
BHC, because the state has an earlier
trigger date (e.g., the Kentucky BHC is
subsequently acquired by a New York
BHC before Ohio's 1988 nationwide
trigger). This would violate Ohio's law,
which would require that the unauthorized
New York BHC divest the Ohio bank.
When Ohio's legislation becomes effective
in October 1985, Ohio banks will be able
to merge with banks in Kentucky and
Indiana, since both states have already
enacted contiguous state reciprocal interstate banking laws that include Ohio
(see map). Of the 11 other states included
in Ohio's legislation, Tennessee, Virginia,
and Maryland recently passed interstate
banking laws, but none includes Ohio.
Bills pending in Wisconsin, Michigan,
New Jersey, Illinois, and Pennsylvania
would extend reciprocity to Ohio. However,
Ohio is excluded in bills pending or
considered in Missouri and in the District
of Columbia. Delaware is not currently
considering interstate banking legislation.

3. According to the Federal Reserve, a federal law
should mandate that regional banking pacts have a
three-year trigger. which would convert them to
nationwide reciprocity. Some bankers strongly oppose
nationwide triggers and would like to permanently
bar the money-center banks.

Figure 1 Status of Interstate Banking Legislation: States Included in Ohio's Law

Table 1 Ohio Bank Holding Company Acquisitions
of Large Intrastate Banking Organizations

Since 1980

•

r-:l

L-J

Laws currently
including Ohio

passed

Deposit ranking

including

NOTE: Indiana's
effective January

1982

National City Corporation
Ohio Citizens Bancorp., Inc.

4th
16th

1st

$8.8

6th
11th

5th

4.1

1983

Bane One Corporation
Winters National Corporation

3rd
11th

2nd

7.6

1984

Society Corporation
Interstate
Financial

6th
15th

3rd

7.0

National City Corporation
BancOhio Corporation

4th
2nd

1st

8.8

Society Corporation
Centran Corporation

4th
7th

3rd

7.0

Ohio

Bills pending
excluding Ohio
No bills under
consideration

Deposits,
March 1985C

Banking organizations

Huntington
Bancshares,
Inc.
Union Commerce Corporation

NJ.

Bills pending

After
acq uisition

Year

Laws currently
passed
excluding Ohio

D
D
D

Before
acquisition a

MO.

law becomes
I, 1986.
1985

In West Virginia, an outline of proposed
legislation, which would extend reciprocity
to Ohio, is currently circulating among
members of West Virginia's Bankers
Association.
In Pennsylvania, an interstate banking
bill was pre-filed with the legislature on
August 19, 1985, but passage this fall
seems unlikely because no consensus exists
among Pennsylvania bankers on the bill's
provisions. In Michigan, an interstate
banking bill was passed in 1984, but was
vetoed by the governor. Its future passage,
however, is virtually guaranteed if Michigan
bankers agree to compromise on some
consumer and usury issues.
Implications for Ohio Banks
Ever since Ohio legislators began discussing interstate banking, there has
been speculation about whether or not the
state's banks will grow and prosper as a
result of interstate banking. Some bankers
and communities are concerned that their
banks will eventually be acquired by
out-of-state banks.

4. See Edward E. Furash, "Preparing for Interstate
Banking: Maximizing a Bank's Value," Economic
Review, Federal Reserve Bank of Atlanta, January
1985, pp. 6·11.

The existence of interstate banking does
not necessarily mean that all Ohio banks
will be targets for acquisition. Under
interstate banking, each Ohio bank can
pursue one of three basic long-term
strategies: attempt to be an acquirer, an
acquiree, or position itself to remain
independent.
Regardless of a bank's size, banking
consultants believe that the key to success
in an interstate banking environment is
maximizing shareholder value." The
consultants offer two basic suggestions to
achieve this: (1) a bank should excel at
basic banking, focusing on achieving a
high net interest margin - that is, the
difference between interest earned and
interest paid, and (2) the bank should
work to hold a loyal customer base. This
strategy might enable the bank to build
enough strength to remain independent.
Pursuing such a strategy, a bank would
be in a good position to buy weaker banks,
inasmuch as this action would have little
impact on the earnings of stockholders.
Also, the bank could choose to merge
with a strong bank among its peers, or
its stockholders could elect to sell out
and to reap the rewards of their higher
shareholder value.

5. See John Danforth, "An Overview of Acquirers'
Strategic Choices," pp. 12·15; Jon Burke, "Strategies
for Potential Acquirees," pp. 16·20; and David
C. Cates, "Prices Paid for Banks;' pp. 36·41,
Economic Review, Federal Reserve Bank of Atlanta,
January 1985.

Corp.

b

a. Rankings are as of date prior to acquisition.
b. Rankings are based on March 1985 deposit size.
c. Billions of dollars.

interstate banking strategies. Several
strategies are open to Ohio BHCs that are
interested in interstate operations." For
Ohio's larger BHCs, the regional banking
pact would give them three years to
accumulate additional assets and to achieve
what many banking analysts refer to as
critical size. A large asset size, say over
$15 billion, would make it more expensive
for out-of-state money-center banks to
purchase Ohio's larger BHCs. Research
findings have yet to pinpoint the minimum
size necessary to stave off most acquisitions.
Thus, the concept of critical size is more
heuristic than concrete.
In a recent study by the Federal Reserve
Bank of New York, it was observed that
the financial costs of absorbing a major
bank acquistion would become severe
when the acquiree bank is at least 20
percent as large as the acquirer bank,
and the purchase premium approaches
50 percent. 6 Regional banks, with high
capital ratios and strong earnings performance, are attractive to potential acquirers.

However, these same financial characteristics make regional banks more costly to
acquire. Regional banks become even
more expensive acquisitions if they
accumulate additional assets and remain
strong, highly capitalized performers,
Since 1982, Ohio's largest BHCs have
been accumulating critical size through a
number of intrastate mergers (see table 1)_
If Ohio's largest banks continue to grow,
they will be in a better competitive position when nationwide banking arrives.
Interstate banking would also benefit
Ohio BHCs by allowing them to consolidate
operations after an acquisition, thus
reducing data processing, operations,
product development, and marketing costs.
It is uncertain to what extent cost red uctions could be realized, because economic
studies show that large size is not required
to become an efficient producer of banking
services." As interstate acquirers, Ohio
BHCs could diversify their deposit base
as well as the mixture of their assets."
Recently, money-center banks have
suffered high loan losses, and higher
regulatory capital standards have been
imposed on them, forcing them to reduce

6. See Leon Korobow and George Budzeika,
"Financial Limits on Interstate Bank Expansion."
Quarterly Reoicio, Federal Reserve Bank of New York,
vol. 10, no. 2 (Summer 1985), pp. 13-27. This
study finds that, because of the costs involved in
acquiring regional banks, interstate acquisitions
would be self- limiting. As a result, money-center
banks would have to be selective in their interstate
acq uisi tions.

7. These economic studies, which found cost reductions
at a low output level, were conducted when banking
was highly regulated. It is not clear how a deregulated,
more technological environment
has affected
bank cost.

lending, which adversely affects their
earnings. Our financial analysis of Ohio
banks shows that Ohio's largest BHCs are
highly capitalized, which explains why they
are particularly attractive to money-center
banks. Ohio banks also hold another
valuable commodity that makes them
attractive acquirees, As banking becomes
deregulated, banks pay market interest
rates on the bulk of their deposits, which
ironically now represents their core deposit
base. Like their counterparts elsewhere,
Ohio banks pay market rates on most of
their deposits; however, they also typically
have a less volatile deposit base, and
some continue to reap lower costs because
of a larger-than-typical level of low-rate,
rate-ceiling deposits."
Banking structu re in Ohio and selecLed
states. According to the recent status of
interstate banking legislation, seven states
have legislation or bills pending that
would include Ohio on a reciprocal basis.
Ohio is included in legislation enacted by
Kentucky and Indiana and would be extended reciprocity in bills pending in
Michigan, Pennsylvania, Wisconsin,
New Jersey, and Illinois. Table 2 examines
several aspects of these states' commercial
banking structures. This allows us to
infer about possible implications of interstate
banking for Ohio banks strictly from a
structure perspective.
Currently, Ohio has total commercial
banking deposits of approximately $56
billion; it ranks seventh nationwide in size
of deposits. As of year-end 1984, Ohio
had 239 banking organizations after consolidating the banking subsidiaries of
BHCs_ There are 66 BHCs operating in
Ohio with control over $49 billion in
deposits, representing 87 percent of statewide commercial bank deposits. Fifty-one
of Ohio's BHCs have deposits of less than

8_ There is disagreement
about whether regional
banking is superior to the status quo or to a nationwide banking system. For a comparison of regionalism
with other major alternatives, see Donald T. Savage,
"The Alternative of Regional Interstate Banking,"
Issues in Bank Regulation, Autumn 1984, pp. 3-10.
Savage concludes that regional banking is not likely
to produce significant efficiencies for consumers or
for banks. He argues further that regionalism would

The other amendment added savings and
loan institutions to the legislation.
Under Ohio's legislation, reciprocity is
extended to commercial banks and to
savings and loan institutions in Michigan,
Indiana, Kentucky, West Virginia,
Pennsylvania, Missouri, Wisconsin, Illinois,
Tennessee, Virginia, Maryland, Delaware,
New Jersey, and the District of Columbia.
The law becomes effective October 17,
1985. It also provides that, after October
16, 1988, Ohio will grant reciprocal entry
to any state on a nationwide basis.
A BHC entering Ohio must have its
principal place of business (that is, 51
percent of its deposits) in an authorized
reciprocating state. This prevents excluded
banking organizations from entering Ohio
through what is referred to as leapfrogging.
To illustrate: assume that an out-of-state
acquisition of an Ohio bank is legal initially
(e.g., a Kentucky BHC acquires an Ohio
bank). Now assume that the BHC is subsequently acquired itself by another BHC
in an unauthorized state, say a New York
BHC, because the state has an earlier
trigger date (e.g., the Kentucky BHC is
subsequently acquired by a New York
BHC before Ohio's 1988 nationwide
trigger). This would violate Ohio's law,
which would require that the unauthorized
New York BHC divest the Ohio bank.
When Ohio's legislation becomes effective
in October 1985, Ohio banks will be able
to merge with banks in Kentucky and
Indiana, since both states have already
enacted contiguous state reciprocal interstate banking laws that include Ohio
(see map). Of the 11 other states included
in Ohio's legislation, Tennessee, Virginia,
and Maryland recently passed interstate
banking laws, but none includes Ohio.
Bills pending in Wisconsin, Michigan,
New Jersey, Illinois, and Pennsylvania
would extend reciprocity to Ohio. However,
Ohio is excluded in bills pending or
considered in Missouri and in the District
of Columbia. Delaware is not currently
considering interstate banking legislation.

3. According to the Federal Reserve, a federal law
should mandate that regional banking pacts have a
three-year trigger. which would convert them to
nationwide reciprocity. Some bankers strongly oppose
nationwide triggers and would like to permanently
bar the money-center banks.

Figure 1 Status of Interstate Banking Legislation: States Included in Ohio's Law

Table 1 Ohio Bank Holding Company Acquisitions
of Large Intrastate Banking Organizations

Since 1980

•

r-:l

L-J

Laws currently
including Ohio

passed

Deposit ranking

including

NOTE: Indiana's
effective January

1982

National City Corporation
Ohio Citizens Bancorp., Inc.

4th
16th

1st

$8.8

6th
11th

5th

4.1

1983

Bane One Corporation
Winters National Corporation

3rd
11th

2nd

7.6

1984

Society Corporation
Interstate
Financial

6th
15th

3rd

7.0

National City Corporation
BancOhio Corporation

4th
2nd

1st

8.8

Society Corporation
Centran Corporation

4th
7th

3rd

7.0

Ohio

Bills pending
excluding Ohio
No bills under
consideration

Deposits,
March 1985C

Banking organizations

Huntington
Bancshares,
Inc.
Union Commerce Corporation

NJ.

Bills pending

After
acq uisition

Year

Laws currently
passed
excluding Ohio

D
D
D

Before
acquisition a

MO.

law becomes
I, 1986.
1985

In West Virginia, an outline of proposed
legislation, which would extend reciprocity
to Ohio, is currently circulating among
members of West Virginia's Bankers
Association.
In Pennsylvania, an interstate banking
bill was pre-filed with the legislature on
August 19, 1985, but passage this fall
seems unlikely because no consensus exists
among Pennsylvania bankers on the bill's
provisions. In Michigan, an interstate
banking bill was passed in 1984, but was
vetoed by the governor. Its future passage,
however, is virtually guaranteed if Michigan
bankers agree to compromise on some
consumer and usury issues.
Implications for Ohio Banks
Ever since Ohio legislators began discussing interstate banking, there has
been speculation about whether or not the
state's banks will grow and prosper as a
result of interstate banking. Some bankers
and communities are concerned that their
banks will eventually be acquired by
out-of-state banks.

4. See Edward E. Furash, "Preparing for Interstate
Banking: Maximizing a Bank's Value," Economic
Review, Federal Reserve Bank of Atlanta, January
1985, pp. 6·11.

The existence of interstate banking does
not necessarily mean that all Ohio banks
will be targets for acquisition. Under
interstate banking, each Ohio bank can
pursue one of three basic long-term
strategies: attempt to be an acquirer, an
acquiree, or position itself to remain
independent.
Regardless of a bank's size, banking
consultants believe that the key to success
in an interstate banking environment is
maximizing shareholder value." The
consultants offer two basic suggestions to
achieve this: (1) a bank should excel at
basic banking, focusing on achieving a
high net interest margin - that is, the
difference between interest earned and
interest paid, and (2) the bank should
work to hold a loyal customer base. This
strategy might enable the bank to build
enough strength to remain independent.
Pursuing such a strategy, a bank would
be in a good position to buy weaker banks,
inasmuch as this action would have little
impact on the earnings of stockholders.
Also, the bank could choose to merge
with a strong bank among its peers, or
its stockholders could elect to sell out
and to reap the rewards of their higher
shareholder value.

5. See John Danforth, "An Overview of Acquirers'
Strategic Choices," pp. 12·15; Jon Burke, "Strategies
for Potential Acquirees," pp. 16·20; and David
C. Cates, "Prices Paid for Banks;' pp. 36·41,
Economic Review, Federal Reserve Bank of Atlanta,
January 1985.

Corp.

b

a. Rankings are as of date prior to acquisition.
b. Rankings are based on March 1985 deposit size.
c. Billions of dollars.

interstate banking strategies. Several
strategies are open to Ohio BHCs that are
interested in interstate operations." For
Ohio's larger BHCs, the regional banking
pact would give them three years to
accumulate additional assets and to achieve
what many banking analysts refer to as
critical size. A large asset size, say over
$15 billion, would make it more expensive
for out-of-state money-center banks to
purchase Ohio's larger BHCs. Research
findings have yet to pinpoint the minimum
size necessary to stave off most acquisitions.
Thus, the concept of critical size is more
heuristic than concrete.
In a recent study by the Federal Reserve
Bank of New York, it was observed that
the financial costs of absorbing a major
bank acquistion would become severe
when the acquiree bank is at least 20
percent as large as the acquirer bank,
and the purchase premium approaches
50 percent. 6 Regional banks, with high
capital ratios and strong earnings performance, are attractive to potential acquirers.

However, these same financial characteristics make regional banks more costly to
acquire. Regional banks become even
more expensive acquisitions if they
accumulate additional assets and remain
strong, highly capitalized performers,
Since 1982, Ohio's largest BHCs have
been accumulating critical size through a
number of intrastate mergers (see table 1)_
If Ohio's largest banks continue to grow,
they will be in a better competitive position when nationwide banking arrives.
Interstate banking would also benefit
Ohio BHCs by allowing them to consolidate
operations after an acquisition, thus
reducing data processing, operations,
product development, and marketing costs.
It is uncertain to what extent cost red uctions could be realized, because economic
studies show that large size is not required
to become an efficient producer of banking
services." As interstate acquirers, Ohio
BHCs could diversify their deposit base
as well as the mixture of their assets."
Recently, money-center banks have
suffered high loan losses, and higher
regulatory capital standards have been
imposed on them, forcing them to reduce

6. See Leon Korobow and George Budzeika,
"Financial Limits on Interstate Bank Expansion."
Quarterly Reoicio, Federal Reserve Bank of New York,
vol. 10, no. 2 (Summer 1985), pp. 13-27. This
study finds that, because of the costs involved in
acquiring regional banks, interstate acquisitions
would be self- limiting. As a result, money-center
banks would have to be selective in their interstate
acq uisi tions.

7. These economic studies, which found cost reductions
at a low output level, were conducted when banking
was highly regulated. It is not clear how a deregulated,
more technological environment
has affected
bank cost.

lending, which adversely affects their
earnings. Our financial analysis of Ohio
banks shows that Ohio's largest BHCs are
highly capitalized, which explains why they
are particularly attractive to money-center
banks. Ohio banks also hold another
valuable commodity that makes them
attractive acquirees, As banking becomes
deregulated, banks pay market interest
rates on the bulk of their deposits, which
ironically now represents their core deposit
base. Like their counterparts elsewhere,
Ohio banks pay market rates on most of
their deposits; however, they also typically
have a less volatile deposit base, and
some continue to reap lower costs because
of a larger-than-typical level of low-rate,
rate-ceiling deposits."
Banking structu re in Ohio and selecLed
states. According to the recent status of
interstate banking legislation, seven states
have legislation or bills pending that
would include Ohio on a reciprocal basis.
Ohio is included in legislation enacted by
Kentucky and Indiana and would be extended reciprocity in bills pending in
Michigan, Pennsylvania, Wisconsin,
New Jersey, and Illinois. Table 2 examines
several aspects of these states' commercial
banking structures. This allows us to
infer about possible implications of interstate
banking for Ohio banks strictly from a
structure perspective.
Currently, Ohio has total commercial
banking deposits of approximately $56
billion; it ranks seventh nationwide in size
of deposits. As of year-end 1984, Ohio
had 239 banking organizations after consolidating the banking subsidiaries of
BHCs_ There are 66 BHCs operating in
Ohio with control over $49 billion in
deposits, representing 87 percent of statewide commercial bank deposits. Fifty-one
of Ohio's BHCs have deposits of less than

8_ There is disagreement
about whether regional
banking is superior to the status quo or to a nationwide banking system. For a comparison of regionalism
with other major alternatives, see Donald T. Savage,
"The Alternative of Regional Interstate Banking,"
Issues in Bank Regulation, Autumn 1984, pp. 3-10.
Savage concludes that regional banking is not likely
to produce significant efficiencies for consumers or
for banks. He argues further that regionalism would

$500 million; all except six of them are
one-bank (unitary) BHCs. Ohio has eight
banking organizations whose deposits
exceed $2 billion, and five whose deposits
exceed $4 billion. The state's three largest
banking organizations control, on average,
about $7 billion in deposits. Ohio's three
largest banking organizations control
38 percent of statewide commercial
banking deposits, thus classifying the
state's banking structure as moderately
concentrated.
When compared to banks in Indiana and
Kentucky, Ohio banks obviously have a
formidable size advantage. Ohio's largest
institutions are four times larger than
the largest banks in Indiana and Kentucky.
While their smaller deposit base partly
explains their relatively smaller deposit
size, until very recently, Indiana and
Kentucky had more restrictive intrastate
banking laws, which also accounts for the
disparity. Consequently, in contrast to
Ohio, banking structure in these states is
unconcentrated - both in an absolute
and relati ve sense.
Among those five states whose interstate
banking bills would extend reciprocity
to Ohio, Ohio banks would retain a size
advantage, or would at least maintain
size parity, with banks in Michigan,
Wisconsin, and New Jersey. When compared to Ohio, Michigan has fewer total
deposits but has slightly larger institutions.
It also has fewer banks and is slightly
more concentrated. Although banking in
New Jersey is as concentrated as in Ohio,
its deposit base is below Ohio's, and
there are fewer organizations with a smaller
average deposit size. Wisconsin's banking
structure essentially falls between the
structures of Indiana and Kentucky.
Banks in Pennsylvania and Illinois
currently have a size advantage over
banks in Ohio. While deposits in these
states are less concentrated than in Ohio,
Pennsylvania and Illinois banks have a
larger deposit base and have larger banks.

reduce the number of candidates attractive to acquirers
in a nationwide banking environment
and would
lead to higher concentration.

Table 2 Commercial Banking Structure in Selected States
As of December 31, 1984
Average

State"

Total commercial bank
deposits>

Ohio

Nationwide
deposit
ranking

Number of
banking
organizations

Three
largest
banking
organizations!'

$56.1

7

239

$7.1

Indiana

35.3

12

375

Kentucky

22.3

23

329

2.1
1.9

Michigan

53.5

8

194

Pennsylvania

86.8

5

308

Wisconsin

29.3

17

440

deposit

size

Ten
largest
banking
organizations!'
$4.0
I.l

Three-firm
concentra-

tion ratio
38%
18

0.8

26

7.3

3.8

41

10.1
2.9

5.0
1.3

30

35

44.3

9

96

5.8

2.9

39

Illinois

100.3

4

1,093

9.0

3.7

27

New York

309.1

326

27.8

16.1

27

New Jersey

a. All of these states, except New York, are included in Ohio's legislation, and they have passed or are considering interstate banking legislation that would include Ohio.
b. Billions of dollars.

Although Illinois has a larger deposit
base and two large banks with combined
deposits of $44 billion, Pennsylvania
banks are more likely to pose a takeover
threat to Ohio banks. Illinois has only
four banks whose deposit size exceeds
$2 billion; Pennsylvania has 10 banks
whose deposits exceed $2 billion.

Financial condition 0/ Ohio's la rgest
BHCs. By examining the balance sheets

of Ohio's 15 largest BHCs, we can assess
their potential as interstate acquirers.'?
Because of different, size-oriented financial
ratios, the 15 BI-ICs are divided into two
peer groups. Seven Ohio BHCs fall into
one group with consolidated assets
exceeding $3 billion. The eight other Ohio
BHCs have assets from $500 million to
$3 billion. By examining key financial
ratios and comparing the Ohio BHCs by
peer group with their BHC counterparts
nationwide, we can characterize their
general financial health. However, no
inferences are drawn about any single
BHC's financial capability as an acquirer,

9. One measure of deposit base stability is a liquidity
ratio called volatile liability dependence, which
shows what percentage of a bank's loans and
investments are funded by volatile liabilities, such
as large time deposits, foreign deposits, and
commercial paper. For Ohio's 15 largest BHCs, this
ratio was, on average, only one-half the ratio of their
peer BHCs, as of year-end 1984.

because the diversity of their respective
operations makes it difficult to set broad
guidelines for measuring their financial
ability to acquire other banking organizations.
Return on assets (ROA) is the crucial
financial factor in a BHC's performance.
ROA, defined as the ratio of income to
assets, is an indicator of how well a bank
is using its assets. As defined earlier,
a second profitability measure, net interest
income, measures the margin of interest
earned over interest paid by a bank.
When compared to their BHC counterparts, Ohio's largest banks were more
profitable in 1984 and essentially matched
the net interest margin of their peers
(see table 3). The positive ROA gap
between Ohio BHCs and their peers was
substantial, particularly for smaller
Ohio BHCs.
We continue the analysis by examining
the level of capital relative to the BHCs'
volume of operations. Capital, in effect,
is a cushion against unforseen financial
losses and, as such, represents a constraint
on how much a bank's operations can be
leveraged. Banking regulators recently
tightened capital standards for banks. As

10. In evaluating the merits of a BHC acquisition,
the Federal Reserve assesses financial factors and
looks at management,
the acquisition's effect on
banking competition, and the impact <ifthe acquisition
on the acquired bank's community.

Table 3 Selected Financial Ratios for Ohio's Largest
Banking Organizations and Nationwide Peers a
As of December
31, 1984
BffCs with assets
greater than
$3 billion!'

BblCs with assets
from $500 million
to $3 billion C

Ohio

Financial

ratios

Profitability and earnings
Return on average assets
Net interest income

BHe
peers

Ohio
BHes

BHe
peers

1.04
4.77

0.76
4.77

1.19
4.94

0.76
5.13

7.52
10.10

6.69
7.76

9.08
8.77

7.22
7.66

17.23d
18.01 d

11.37
11.03

9.58
10.63

16.05
16.61

19.15
12.56

49.25
22.46

5.11
4.48

30.48
17.68

0.45
1.24

0.57
1.32

0.50
1.19

0.60
1.21

sues

Capitalization
Primary
Retained

capital/total
assets
earnings/average
equity

Growth rates
Assets
Primary

capital

Leverage (parentcornpany)
Total debt/equity
Long-term debt/equity

Loan loss analysis
Net loan losses/average
total loans
Allowances
for loan losses/total
loans

a. Ratios are averages for Ohio BHCs in each peer group and for BHC counterparts nationwide.
b. Ratios in this BHC peer category are the weighted average of two BHC peer classifications: those with assets
exceeding $10 billion and those with assets between $3 billion and $10 billion. To compute the average ratio for
nationwide BHC peers, the two peer ratios were weighted according to the number of Ohio BHCs in each peer
classification.
c. Ratios in this BHC peer category are the weighted average of BHCs with assets between $500 million and $1 billion, and between $1 billion and $3 billion.
d. Growth rates exclude BHC acquisitions in 1984.
SOURCE: Bank Holding Company Performance Reports, December 31, 1984, Board of Governors of the Federal
Reserve System.

discussed earlier, higher capital standards
have primarily affected the nation's
largest banks.
Some regulators are now proposing even
stiffer capital standards for banks.
Under one proposal, capital levels would
be raised from 5.5 percent to as high as
9 percent. Another proposal would apply
risk-based capital rules to banks that
make riskier investments. (All banks now
maintain the same level of capital, regardless of the nature of their activities.)
It is not clear whether these proposals
would affect larger banks more than smaller
banks. If implemented, tighter capital
standards would not only slow the growth
of the banking system, but also would
slow the pace of interstate banking.
Because Ohio banks are relatively more
highly capitalized than banks of similar
size throughout the country, they would
be less affected by higher capital standards.

Similarly, if risk-based capital rules
were implemented, Ohio banks would be
largely unaffected, because they have
generally avoided high-risk investments.
As BHCs grow, the rate at which they
generate capital internally affects how
rapidly they can expand externally and
avoid further leveraging of operations and
lowering of capital ratios. Thus, we look
at the ratio of retained earnings to equity
as an indicator of the speed at which
the Ohio BHCs can add assets without
additional leveraging. We also look at
growth rates for assets and capital and
examine two ratios that measure how
much the Ohio BHCs' parent companies
rely on debt in their capital structure.
According to our analysis, both Ohio
BHC groups are much better capitalized

11. Since 1980, the larger BHCs experienced asset
and capital growth rates on average about 3 percent
below their peers. The smaller BHCs had a five-year
average asset growth rate 3 percent below peers,
while their average capital growth rate was more
than 4 percent below that of peers.

relative to their peer El-ICs. Although
there is an expected inverse relationship
between the asset size of the Ohio BHCs
and capital adequacy, the Ohio BHCs'
capital adequacy relative to that of their
peers improves as size decreases. This
means that Ohio's smaller BHCs are more
highly capitalized than the larger BHCs,
after adjusting for size differences. Both
Ohio BHC groups had relatively higher
ratios of retained earnings to equity,
especially the larger BHCs_
In 1984, the larger Ohio BHCs had a
relatively higher growth rate of capital
and assets. Their performance, however,
is atypical of the El-ICs' performance on
average since 1980.11 For smaller Ohio
BHCs, the growth rates of assets and
capital in 1984 were substantially below
peer BHCs_ Lower relative asset growth
by Ohio banks is undoubtedly linked to
the state's slow economic recovery. In the
1981-82 recession, Ohio's economy
suffered a deeper decline than the nation
as a whole, and Ohio's recovery has been
lagging the nation's." Also, it is readily
apparent that both Ohio BHC groups are
much less indebted than their peers.
Finally, we examine the loan loss
experience of Ohio BHCs_ High loan
losses not only would impair earnings
performance, but could affect the rate of
internal capital generation. If a BHC has
high loan losses, it would have to rebuild
its loan loss reserves, which are considered
a part of capital. In this circumstance,
unless a BHC slows its rate of asset growth,
high loan losses would put more pressure
on its earnings.
The analysis shows that the Ohio
BHCs had lower loan losses; this reflects
Ohio bankers' more conservative banking
philosophy, which has resulted in a history
of strong credit quality, In fact, Ohio's
largest banks have resisted an industry
trend toward riskier investments. They
have avoided becoming embroiled in nonperforming energy and farm loan problems
and lending problems that involve
developing countries.

12. Non-agricultural
employment, one measure of
economic performance, declined only 0.9 percent
nationally from 1980 to 1982, but fell 5.6 percent
in Ohio during the same time period. Employment
rose nationally 5.4 percent between 1982 and 1984,
but grew only 5.4 percent in Ohio during those
two years.

Concluding Remarks
Interstate banking should not threaten the
independence of Ohio's large banks.
Ohio banks have an opportunity to be a
viable part of midwestern banking and
eventually of a nationwide banking system
as well. Despite banking deregulation,
new banking technologies, higher capital
standards, and a sluggish midwestern
economic recovery, Ohio's largest banks
are favorably positioned to enter interstate markets.
If Ohio's larger banks make prudent
strategic choices before the state's 1988
nationwide trigger - that is, if they grow
and maintain strength - then they can
look forward to aggressively entering
out-of-state markets, rather than defending
themselves from takeovers by out-of-state
banks.
Currently, a window 0/ opportunity exists
for Ohio BHCs, because they have a size
advantage in the Midwest. However, this
advantage will disappear in the next year
or so, when states such as Pennsylvania
and Illinois enact interstate banking
legislation.

Federal Reserve Bank of Cleveland
Research Department
PO. Box 6387
Cleveland, OH 44101

Address Correction Requested: Please send
corrected mailing label to the Federal Reserve
Bank of Cleveland, Research Department,
P.O. Box 6387, Cleveland, OH 44101.

BULK RATE
U.S. Postage Paid
Cleveland, OH
Permit No. 385

Table 3 Selected Financial Ratios for Ohio's Largest
Banking Organizations and Nationwide Peers a
As of December
31, 1984
BffCs with assets
greater than
$3 billion!'

BblCs with assets
from $500 million
to $3 billion C

Ohio

Financial

ratios

Profitability and earnings
Return on average assets
Net interest income

BHe
peers

Ohio
BHes

BHe
peers

1.04
4.77

0.76
4.77

1.19
4.94

0.76
5.13

7.52
10.10

6.69
7.76

9.08
8.77

7.22
7.66

17.23d
18.01 d

11.37
11.03

9.58
10.63

16.05
16.61

19.15
12.56

49.25
22.46

5.11
4.48

30.48
17.68

0.45
1.24

0.57
1.32

0.50
1.19

0.60
1.21

sues

Capitalization
Primary
Retained

capital/total
assets
earnings/average
equity

Growth rates
Assets
Primary

capital

Leverage (parentcornpany)
Total debt/equity
Long-term debt/equity

Loan loss analysis
Net loan losses/average
total loans
Allowances
for loan losses/total
loans

a. Ratios are averages for Ohio BHCs in each peer group and for BHC counterparts nationwide.
b. Ratios in this BHC peer category are the weighted average of two BHC peer classifications: those with assets
exceeding $10 billion and those with assets between $3 billion and $10 billion. To compute the average ratio for
nationwide BHC peers, the two peer ratios were weighted according to the number of Ohio BHCs in each peer
classification.
c. Ratios in this BHC peer category are the weighted average of BHCs with assets between $500 million and $1 billion, and between $1 billion and $3 billion.
d. Growth rates exclude BHC acquisitions in 1984.
SOURCE: Bank Holding Company Performance Reports, December 31, 1984, Board of Governors of the Federal
Reserve System.

discussed earlier, higher capital standards
have primarily affected the nation's
largest banks.
Some regulators are now proposing even
stiffer capital standards for banks.
Under one proposal, capital levels would
be raised from 5.5 percent to as high as
9 percent. Another proposal would apply
risk-based capital rules to banks that
make riskier investments. (All banks now
maintain the same level of capital, regardless of the nature of their activities.)
It is not clear whether these proposals
would affect larger banks more than smaller
banks. If implemented, tighter capital
standards would not only slow the growth
of the banking system, but also would
slow the pace of interstate banking.
Because Ohio banks are relatively more
highly capitalized than banks of similar
size throughout the country, they would
be less affected by higher capital standards.

Similarly, if risk-based capital rules
were implemented, Ohio banks would be
largely unaffected, because they have
generally avoided high-risk investments.
As BHCs grow, the rate at which they
generate capital internally affects how
rapidly they can expand externally and
avoid further leveraging of operations and
lowering of capital ratios. Thus, we look
at the ratio of retained earnings to equity
as an indicator of the speed at which
the Ohio BHCs can add assets without
additional leveraging. We also look at
growth rates for assets and capital and
examine two ratios that measure how
much the Ohio BHCs' parent companies
rely on debt in their capital structure.
According to our analysis, both Ohio
BHC groups are much better capitalized

11. Since 1980, the larger BHCs experienced asset
and capital growth rates on average about 3 percent
below their peers. The smaller BHCs had a five-year
average asset growth rate 3 percent below peers,
while their average capital growth rate was more
than 4 percent below that of peers.

relative to their peer El-ICs. Although
there is an expected inverse relationship
between the asset size of the Ohio BHCs
and capital adequacy, the Ohio BHCs'
capital adequacy relative to that of their
peers improves as size decreases. This
means that Ohio's smaller BHCs are more
highly capitalized than the larger BHCs,
after adjusting for size differences. Both
Ohio BHC groups had relatively higher
ratios of retained earnings to equity,
especially the larger BHCs_
In 1984, the larger Ohio BHCs had a
relatively higher growth rate of capital
and assets. Their performance, however,
is atypical of the El-ICs' performance on
average since 1980.11 For smaller Ohio
BHCs, the growth rates of assets and
capital in 1984 were substantially below
peer BHCs_ Lower relative asset growth
by Ohio banks is undoubtedly linked to
the state's slow economic recovery. In the
1981-82 recession, Ohio's economy
suffered a deeper decline than the nation
as a whole, and Ohio's recovery has been
lagging the nation's." Also, it is readily
apparent that both Ohio BHC groups are
much less indebted than their peers.
Finally, we examine the loan loss
experience of Ohio BHCs_ High loan
losses not only would impair earnings
performance, but could affect the rate of
internal capital generation. If a BHC has
high loan losses, it would have to rebuild
its loan loss reserves, which are considered
a part of capital. In this circumstance,
unless a BHC slows its rate of asset growth,
high loan losses would put more pressure
on its earnings.
The analysis shows that the Ohio
BHCs had lower loan losses; this reflects
Ohio bankers' more conservative banking
philosophy, which has resulted in a history
of strong credit quality, In fact, Ohio's
largest banks have resisted an industry
trend toward riskier investments. They
have avoided becoming embroiled in nonperforming energy and farm loan problems
and lending problems that involve
developing countries.

12. Non-agricultural
employment, one measure of
economic performance, declined only 0.9 percent
nationally from 1980 to 1982, but fell 5.6 percent
in Ohio during the same time period. Employment
rose nationally 5.4 percent between 1982 and 1984,
but grew only 5.4 percent in Ohio during those
two years.

Concluding Remarks
Interstate banking should not threaten the
independence of Ohio's large banks.
Ohio banks have an opportunity to be a
viable part of midwestern banking and
eventually of a nationwide banking system
as well. Despite banking deregulation,
new banking technologies, higher capital
standards, and a sluggish midwestern
economic recovery, Ohio's largest banks
are favorably positioned to enter interstate markets.
If Ohio's larger banks make prudent
strategic choices before the state's 1988
nationwide trigger - that is, if they grow
and maintain strength - then they can
look forward to aggressively entering
out-of-state markets, rather than defending
themselves from takeovers by out-of-state
banks.
Currently, a window 0/ opportunity exists
for Ohio BHCs, because they have a size
advantage in the Midwest. However, this
advantage will disappear in the next year
or so, when states such as Pennsylvania
and Illinois enact interstate banking
legislation.

Federal Reserve Bank of Cleveland
Research Department
PO. Box 6387
Cleveland, OH 44101

Address Correction Requested: Please send
corrected mailing label to the Federal Reserve
Bank of Cleveland, Research Department,
P.O. Box 6387, Cleveland, OH 44101.

BULK RATE
U.S. Postage Paid
Cleveland, OH
Permit No. 385