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Working Paper 80-l
EVOLUTION IN BANKING COMPETITION
Walter A. Varvel
Federal Reserve Bank of Richmond
Henry C. Wallich
Member,
Roard of Governors of the Federal Reserve System

September 1980

The views expressed here are solely those of the
authors and do not necessarilv reflect the views
of the Federal Reserve Rank of Richmond or the
Board of Governors of the Federal Reserve System.

EVOLUTION IN BANKING COMPETITION

The Supreme Court view of commercial banking as a "distinct line
of commerce" no longer reflects market realities in many sections of the
United States. The argument used by the Court to support its findings
were not universally endorsed at the time. Today they have been sufficiently
eroded by changing competitive conditions and financial innovations in the
markets for financial services to require a reassessment of the competitive
position of commercial banks.
The "line of commerce" view remains an integral part of the
competitive analysis conducted by Federal banking agencies in connection
with proposed bank mergers and acquisitions. Supreme Court determinations
of the appropriate definitions of the product line and geographic markets
in banking directly influence the market structure variables that are used
by regulators as indicators of market competition. Experience over the
last two decades has led regulators to the general view that, for competitive
analysis purposes, banks can be considered to compete only with other banks.
Commercial banking has been treated as a separate line of commerce
because it was thought to offer a unique package or "cluster" of independent
depository and credit services to bank customers. This treatment has the
effect of excluding from definitions of product markets firms that compete
with banks in some but not all service lines. For example, in their role
as financial intermediaries, banks face competition for funds from other
depository institutions as well as from a myriad of liability instruments
offered in the money market.

Moreover, on the asset side of the balance

sheet, bank credit is offered in competition with thrift institutions,
nonbank firms such as finance and insurance companies, and retailers, as
well as the markets for securities and commercial paper.

Exclusion of this

-2-

competition may

at

times

result in overstatements of anticipated anti-

competitive results from bank consolidations.
Innovations in the financial sector are undermining the line of
commerce view by eliminating unique banking services and reducing interdependence among banking products. Developments encouraging the separate
pricing and marketing of banking services are further increasing the effective
competition between banks and other providers of financial services. Recent
legislation extends interest-bearing transaction account authority nationwide
to thrift institutions, substantially expands the scope of their activities,
and provides for the phase-out of deposit interest rate ceilings. In this
environment, a reevaluation of competitive analysis in banking is necessary
to ensure that it reflects the realities of the marketplace.

The Supreme Court Position: Product and Geographic Markets
The Supreme Court, in ruling that commercial banking is the relevant
1
"line of commerce" in bank merger cases, relied upon the following arguments:
(1) some bank products and services are so distinctive that they are essentially
free of effective competition from other financial institutions; (2) other bank
products and services enjoy cost advantages that insulate them from competition
from substitutes offered by other institutions; (3) banking facilities enjoy a
"settled consumer preference" that gives them an advantage over similar nonbank
services; and (4) the "cluster" of products and services termed commercial
banking has economic significance well beyond the various products and
services involved.
In the Philadelphia National Bank case, the Court declared that banks
offer a cluster of products (various kinds of credit) and services (such as

%ee the following Supreme Court decisions: U.S. vs. Philadelphia
National Bank [374 U.S. 321, (1963)], U.S. vs. Phillipsburg National Bank
[399 U.S. 350, (1970)], and U.S. vs. Connecticut National Bank [418 U.S. 656,
(1974)].

-3-

checking accounts and trust services) that are “so distinctive that they are
entirely free of effective competition from products or services of other
financial institutions." In the Court view, banks played a vital and unique
role in the national economy since they alone were permitted to accept demand
deposits. This distinctive power made banks the intermediaries in most
financial transactions. As chief repositories for consumer and commercial
liquid balances, banks facilitate the efficient transfer of funds from units
with surplus funds (creditors) to deficit units (borrowers). Our fractional
reserve system, moreover, allows banks to create new money (deposits) and
credit and magnifies banks' importance to the economy.
Control of the checking account system was believed by the Court to
invest banks with such advantages as to necessitate customer relations with
banks.

Checking account powers were sufficiently important to distinguish

banks from the institutions that most closely resembled them, the thrifts.
Later, in the Connecticut case where thrifts had recently received authority
to offer check-like Negotiable Order of Withdrawal (NOW) accounts to individuals,
the Court again rejected inclusion of savings banks in the same product line
as banks since Connecticut savings banks could not provide comparable
commercial services to business customers.
In the Philadelphia case, the Court found that in other product lines
(e.g., small consumer loans) banks held a competitive advantage over financial
institutions that offered similar products. Banks, the Court argued, relied
upon lower cost funds (i.e., demand and savings deposits) than did their chief
rivals in this market (consumer finance companies) who purchased funds at
market interest rates, in substantial part, from banks.

As stated by the

Court, the reason for this competitive disadvantage is that "only banks obtain
the bulk of their working capital without having to pay interest...thereon, by
virtue of their unique power to accept demand deposits...."

-4-

Cost differentials have not been consistently cited by the Court,
however, to distinguish between bank and competitor services. Regulation Q
authorizes thrift institutions to pay an interest premium on savings and
small time deposits (presently l/4 percent) above what banks can offer on
identical instruments. The Court did not believe this provided a significant
competitive advantage to thrifts, however, in the rivalry for depositors'
funds. On the contrary, bank savings retained the advantage of "settled
consumer preference" due to coincident checking account relationships. In
the Court's Words, "customers are likely to maintain checking and savings
accounts in the same local bank even when higher savings interest is
available elsewhere." Since thrifts were not authorized to offer checking
accounts, it was reasoned, consumers were willing to forego some interest for
the convenience of one-stop banking.
Most importantly, perhaps, the Court has held that it is the cluster
of products and services that full-service banks offer that makes banking a
distinct line of commerce.
"Commercial banks are the only financial institutions in which
a wide variety of financial products and services--some unique
to commercial banking and others not--are gathered together in
one place. The clustering of financial products and services
in banks facilitates convenient access to them for all banking
customers. For some customers, full-service banking makes
possible access to certain products or services that would
otherwise be unavailable to them....'+
The department store nature of banks, in other words, reuresents the only
meaningful alternative for a significant class of customers--reducing the
effective competition provided by nonbank firms. The Court recognizes that
banks do face direct competition in some individual product and service lines,
or submarkets (savings, personal loans, mortgage lending, etc.).

Such

-5submarkets, however, "are not a basis for the disregard of a broader line of
commerce that has economic significance."
In the Court's view, one-stop banking provides individual bank
customers with unique access to the wide range of financial services a
bank offers. Maintaining a personal checking account, for example, provides
a customer with access to a wide range of other bank services, to seek free
financial advice from bank management, and increases the chances of obtaining
credit when needed.

These services would not be available to a significant

number of customers outside of the banking relationship, the Court argued.
In addition, since customer-bank relationships were usually established
because of locational convenience (near residence, employment, or within
shopping patterns), bank customers could minimize the time and resources
expended (transactions costs) searching for and obtaining financial services.
In this way, the Court believed banks maintained a competitive advantage over
thrifts and nondepository institutions and, therefore, the aggregate of bank
products and services should be treated as the relevant product

line for

competitive analysis in bank consolidation proposals.
The uniqueness of some commercial bank products and services, cost
advantages, "consumer preference," one-stop banking, and the importance of
locational convenience have been the dominant considerations in the Court's
position on the appropriate definition of the product market in bank merger
cases. Locational convenience has also played a key role in Court and
regulatory definitions of the geographic markets in competitive analyses.
2
The Court declared that analysis of individual submarkets are
appropriate, however, when considering the effect on competition of a
merger between a commercial bank and another type of financial institution.
[U.S. vs. Phillipsburg National Bank.]

-6-

The Philadelphia National Bank Case
In U.S. vs. Philadelphia National Bank, the Supreme Court stated
that the area of effective competition in the known line of commerce must
be selected from the market area in which the seller operates and to which
the buyer can practicably turn for supplies
:

In banking, the Court observed

that individuals and businesses typically do most of their business with
banks in their local communities since they find it impractical to conduct
their banking business at a distance.
The Court recognized that individual bank customers, however, have
different capabilities in shopping for banking services--"the relevant
geographical market is a function of each separate customer's economic
scale." In general, said the Court, "the smaller the customer, the smaller
is his banking market geographically." In the Court's view, both small
borrowers and depositors were largely limited to their localities for the
satisfaction of their financial needs.

Large customers, on the other hand,

often have convenient access to banking services outside the local area.
Since the economic scale of consumers of bank services varies, the
Court settled on a "workable compromise" to "delineate the area in which bank
customers that are neither very large nor very small find it practical to do
their banking business." The Court acknowledged that this compromise could
only approximate the geographic scope of the relevant market, and that "an
element of fuzziness would seem inherent in any attempt to delineate the
relevant geographical market."

The use of a single "fuzzy" approximation of

the geographic market flows directly from the choice of a single product line
in banking--the cluster of bank products and services. Clearly, a disaggregated
product line (e.g., demand deposits, consumer instalment loans, commercial loans,
etc.) might dictate the use of multiple geographic markets for analytical

-7-

purposes, depending on the respective geographic areas over which the
customers might practicably turn for alternative supplies.
To date, the Court has agreed with the Federal banking agencies
that the local area in which the banks had their offices was an area of
effective competition. The competitive effects of proposed mergers,
therefore, have generally been judged within localized geographic markets.
Analytical Method:

Concentration Ratios.

Section 7 of the Clayton

Act requires the banking agencies to determine whether the effect of a
proposed merger may be to substantially lessen competition. In the Philadelphia
National Bank case, the Court pointed out that a prediction of anticompetitive
effects "is sound only if it is based upon a firm understanding of the structure
of the relevant market; yet the relevant economic data are both comnlex and
elusive." The Court felt that it was necessary to simplify the competitive
analysis in order to provide a guideline for sound business planning and to
insure that Congressional intent was not subverted.
In simplifying the test of illegality, the Court relied on a sense
of intense Congressional concern with a trend toward concentration in the U.S.
economy. This concern, said the Court, "warrants dispensing, in certain cases,
with elaborate proof of market structure, market behavior, or probable anticompetitive effects." The Court thought that "a merger which produces a firm
controlling an undue percentage share of the relevant market, and results in
a significant increase in the concentration of firms in that market, is so
inherently likely to lessen competition substantially that it must be enjoined
in the absence of evidence clearly showing that the merger is not likely to have
such anticompetitive effects." The Court endorsed the use of concentration
3
ratios, therefore, as an indicator of proposed mergers.
3
The use of concentration ratios is not based solely on grounds of
simplification, but also has some empirical support. Concentration measures

-8-

The Court accepts bank deposit concentration ratios as prima facie
evidence in antitrust cases. The burden of proof is shifted to the banks
to show that the ratios do not accurately depict the economic characteristics
of the market.

The Court requires banks to introduce "significant evidence

of the absence of parallel behavior in the pricing or providing of commercial
bank services" in the market.

This is a difficult task since, in the Court's

own terms, relevant data is "complex and elusive.,,4
Competitive analysis has focused on shares of bank deposits (as a
proxy for bank products and services) controlled by individual banks.
Concentration ratios are calculated in cases involving banks determined to
be presently competing within the same geographic market, as well as for
cases involving banks operating in separate banking markets but viewed as
potential or probable future competitors. In existing competition cases,
mergers are generally prohibited if the combined market shares significantly
increase concentration in the market.

In the latter application, a consolidation

is generally not allowed if it either (a) eliminates a procompetitive influence
exerted by an outside bank on a concentrated market or (b) removes a likely
entrant to a concentrated market that can reasonably be expected to contribute
to the future deconcentration of the market.

have been positively related with performance variables such as prices and
profits f0r.a wide range of industries, including banking.. For a summary
of this evidence, see Stephen Rhoades, "Structure and Performance Studies in
Banking: A Summary and Evaluation," Staff-Economic Studies.,
No. 92, Board of
Governors of the Federal Reserve System, 1977. The Structure-Performance
relationship has been questioned, however, by suggestions that concentration,
instead of leading to collusive behavior, actually emerges from competitive
behavior and reflects the superior performance of large firms. For example,
see Yale Brozen, "The Concentration-CollusionDoctrine," Antitrust Law Journal,
1977-78.
4
Demonstrating an absence of parallel behavior is difficult for
products and se&ices subjected to extensive regulatory price restrictions
(e.g., prohibition of interest on demand deposits, deposit rate ceilings,
and usury laws). Administered rates have regularly fallen below market
rates, forcing institutions to uniformly pay (or charge) the maximum allowable
rates.

-9-

Effects on Bank Markets.

The line of commerce view and the resultant

analytical methodology have provided close approximations of actual competitive
conditions in many banking markets.

The policy has undoubtedly preserved

competition among banking institutions in numerous markets by limiting banks'
ability to buy out competitors. This has contributed to preventing increased
banking concentration and possible adverse competitive consequences. In some
markets, however, the predicted anticompetitive effects of a merger proposal
may be overstated, resulting in denials of cases that could have been approved
without significant anticompetitive results.
U.S. antitrust standards declare a consolidation is legal unless it
tends to create a monopoly or substantially reduces competition. The concern
is to prevent one firm or a small group of firms from gaining sufficient market
power to charge monopoly prices and realize monopoly profits.

In cases where

the Court's view misrepresents the actual competitive situation in the market,
however, prohibiting a bank consolidation may represent an unwarranted interference with the free flow of commerce. Competition can be stifled by not
allowing bank ownership to pass from inefficient, unaggressive hands to more
efficient, innovative control. The number of potential bidders for bank stock
is reduced by limiting purchase by existing or potential market participants,
reducing potential demand for bank stock, and lowering its market value.
Empirical studies indicate that banking is subject to economies of
scale, at least for small- and medium-size banks. As output (measured by
the number of accounts serviced) increases, average banking costs generally
increase less than proportionally. Banks growing through consolidation,
therefore, can often economize on resources used to provide banking services.
Bank customers can expect to benefit from lower unit costs either through
lower prices and/or service charges for bank products or through access to

- 10 -

expanded output.

If competitive pressures do not force banks to pass on

savings to customers, bank profits may increase. Bank capital should benefit
through increased retained earnings-enhancing bank asset growth.
The evidence on scale economies in banking has led George Benston
to conclude that "unless a merger reduces meaningful competition, it should
not be prevented. Otherwise, operating and other inefficiencies may be
continued, desirable change stifled, and owners of resources prevented from
using their property as they wish."5

The vast majority of bank merger

proposals, it should be noted, fall well within the range where economies
might be anticipated. Since real private and social costs can result from
prohibiting these consolidations, the analysis used in evaluating the
competitive impact on the relevant product market should be sound.

Inherent Weaknesses
The central core of the Supreme Court's line of commerce determination
is its finding that the entire aggregate of bank products and services
represents an economically significant market.

"[IIt is the cluster of

products and services that full-service banks offer that as a matter of trade
reality makes commercial banking a distinct line of commerce.~3

This finding

and the resulting methodology employed by the Court and banking agencies have
been criticized since its inception. We believe this criticism reflects some
basic flaws in the Court argument.
In a landmark case involving the definition of a relevant product
market, the Court declared that "the conrnoditfes
reasonably interchangeable
by consumers for the same purposes make up that part of the trade or
5
George Benston, "The Optimal Banking Structure: Theory and Evidence,"
Journal of Bank Research, Winter 1973, pp. 220-37.
6
U.S. vs. Philadelphia National Bank.

- 11 7
commerce...."

Based on this standard, it appears the Court has aggregated
_.~

bank products and services beyond the point where commodities are reasonably
interchangeable' by consumers.
The various products and services that banks offer appear to be
customer-specific, i.e., they are directed toward specific customer groups.
There are at least two distinct categories of customers that use bank
.
services--individuals and commercial enterprises. Banks can be viewed as
providing a cluster of consumer products and services to individuals (demand
and savings deposits, consumer and mortgage credit, trust services, etc.)
and a separate cluster to businesses (cash management services, commercial
and industrial loans, etc.). Though individual customers may well benefit
from the provision of either of these clusters by a single institution, there
is very little reason to expect that individuals or businesses utilize both
clusters. There seems to be little or no crossover across cluster categories
by customers. The financial needs of each group are distinct and serve to
restrict their respective demands to different clusters of bank products and
services. Planning and marketing activities reflect this with separate consumer
and corporate departments within banks and separate advertising programs. Indeed,
many banks have chosen to specialize almost exclusively in either the retail
or wholesale sides of the business.
Contrary to the Court's assertion, the entire bank product line,
therefore, does not appear to have economic significance--it does not appear
7
U.S. vs. DuPont & Co. [351 U.S. 377, 395 (1956)]. The emphasis in
this determination, it should be noted, is on the demand characteristics of
the consumers of the product.
8
The Court declared that interchangeability can be shown by demonstrating
either (a) products perform the same function or (b) the responsiveness of the
sales of one product to changes in the price of the other (high price crosselasticity of demand). If "a high cross-elasticity of demand exists between
them;...the products compete in the same market."

- 12 -

to be a relevant market--for it is not marketed to any one class of customers.
It is only across the cluster of consumer products and services that the pricing
or service level decisions of the commercial bank can have an impact on its
consumer clientele.
At the same time, the Court's definition of the line of commerce in
commercial banking excludes products and services of other institutions that
are "interchangeable" with or close substitutes for individual bank services.
Empirical evidence reveals that a high cross-elasticity of demand exists
between bank time deposits and savings deposits at thrifts. Moreover, disintermediation from both bank and thrift deposits, when market interest rates
increase relative to deposit rates, indicates that other market instruments
are at least partial substitutes for these services. Close substitutes for
various bank credit services are similarly offered by nonbank institutions.
Banks cannot make pricing decisions without regard to the availability of
substitute products from both bank and nonbank institutions. Yet the accepted
analytical methodology implies they can.
Use of concentration ratios, including only bank deposits, ignores the
competitive influences exerted by thrifts and other institutions that supply
substitute services. Since the Court's analysis is not affected by the presence
of competition for individual bank services from nonbank firms, the significance
of computed concentration percentages has been seriously questioned. The Court
"blithely assumes that percentages of the same magnitude represent the same
degree of market power, irrespective of the amount of competition from neighboring
markets."

It thus ignores "the extent to which competition from savings and

loan associations, mutual savings banks, and other financial institutions that
are not commercial banks affects the market power of banks."9
9
Justice Harlan, joined in part by Chief Justice Burger, in a dissenting
opinion to the Phillipsburg decision.

- 13 -

If concentration ratios misrepresent the market power of banks,
and the existence of nonbank institutions in the market also affects banks'
ability to influence prices, the predictive usefulness of concentration
ratios that exclude those institutions is diminished. In particular,
judgments based solely on bank deposit concentration, ignoring competitive
realities in the market, may overestimate adverse competitive effects,
leading to unwarranted denials of bank consolidation proposals.
The Court and banking agencies appear at least aware of the danger
10
of sole reliance on concentration ratios. In a 1974 decision,
the Court
acknowledged that concentration ratios "can be unreliable indicators of
actual market behavior." In addition, the Comptroller of the Currency and
Federal Reserve Board have given limited consideration in recent years to
the competitive presence of thrifts in assessing anticompetitive consequences
of proposed mergers.

Concentration ratios are sometimes "shaded" to reflect

significant competition from thrifts when concentration data suggest the case
11
might be borderline.

Erosion by Innovations and New Competition
However justified and effective established interpretations have been
in preserving and promoting competition for banking services, competitive forces
10
U.S. vs. Marine Bancorporation [418 U.S. 602, (1974)).
11
A Board order involving First Bancorp of New Hampshire (November 2,
1978), for example, noted that "thrift institutions held a significant amount
of deposits which lessened the severity of the effects of the proposed transaction on competition in the market." The Board recently approved a larger
New Jersey bank merger, citing significant thrift competition as a factor
(Fidelity Union Bancorporation, June 5, 1980). An even larger New Jersey merger,
presently being contested by the Justice Department, may provide an undated
judicial view of the competitive impact of thrift institutions on banking
markets.

- 14 in these markets have not stood still. Today, banks face intensive competition
across a rapidly broadening scope of product and geographic markets from other
banks, thrifts, and other financial and nonfinancial firms. This evolving
competition represents an attempt by the market system to meet the financial
requirements of the U.S. economy. Price, product, and geographic restrictions
have limited the ability of banks to fulfill these needs and have induced
unregulated sectors of the economy to fill the void.
The new competition banks face has seriously undermined the relevance
of some of the Court determinations in bank competition cases. Today, banks
no longer enjoy a monopoly in the provision of transaction accounts to
consumers. At the same time, banks are experiencing an all-out invasion of
their other product as well as geographic markets from both traditional and
new competitors. In addition, cost advantages banks may have once enjoyed
over competitors have largely been eliminated as banks increasingly rely on
market sources of funds purchased at market interest rates.

The thesis that

banks enjoy a "settled consumer preference" over competing institutions is
hardly supported by the evidence. Finally, strong economic forces are
inducing banks and other institutions to "unbundle" service packages and
separately market and price financial services.
The Supreme Court has deemed some bank services as so unique that they
are entirely free of competition from other financial institutions. Demand
deposits, commercial loans, trust services, and credit card plans have been cited
at various times to distinguish banks from nonbank institutions. Developments
in recent years, however, suggest that the strength of this argument has been
greatly diminished.
Checking accounts were first subjected to thrift competition when S&Ls
were authorized to allow telephone transfers from savings accounts to third

- 15 -

parties in the 1960s.

In 1970, S&Ls were permitted to make preauthorized

nonnegotiable transfers from savings accounts to third parties for household
related expenditures. This authority was expanded to cover any expenditure
in 1975.

In a major development in 1972, state chartered mutual savings

banks began offering Negotiable Order of Withdrawal (NOW) accounts in
Massachusetts and New Hampshire.

In 1974, Congress authorized all depository

institutions in the two states to offer such accounts, a privilege extended
to the remaining New England states in 1976, New York in 1978, and New
Jersey in 1979. Pennsylvania savings banks also offer an instrument
perceived by the public to be the functional equivalent of checks, the
NINOW or noninterest-bearing NOW account. The direct competition between
banks and thrifts for these transaction accounts has been fierce.
In response to the apparent success of the NOW experiment, in
late 1978 Federal regulators authorized automatic transfers from savings
to checking accounts nationwide for banks.

The recently enacted Consumer

Checking Account Equity Act of 1980 extends NOW account authority nationwide
to all federally insured banks, savings banks and S&Ls.
Another development of large dimension was the credit union share
draft, first authorized on an experimental basis in 1974 and made permanent
in 1978.

Share drafts and consumer lending powers at credit unions present

major new competition for banks, since there are over 22,000 credit unions
in the country with total membership including nearly 25 percent of all
American households.
The new banking legislation also expands the ability of S&Ls to
compete effectively with banks for consumer business. S&Ls are newly enabled
to diversify their portfolios to hold up to 20 percent of total assets in
consumer loans, commercial paper, and corporate debt securities. They are

- 16 -

further authorized to engage in credit card operations and to exercise trust
powers similar to national banks.

These services eliminate several key

distinctions between banks and S&Ls, at least with respect to services
offered to consumers.
In addition, S&Ls do make commercial and business loans secured by
real estate and, since the 196Os, have offered savings accounts to state and
local governments and businesses. Savings banks generally have wider authority
to provide business services. In several states these institutions can make
commercial and business loans. Though these institutions have not presented
major competition to bank commercial services to date, the recent legislation
authorizing federally chartered savings banks to hold up to five percent of
their assets in commercial and industrial loans and to accept business demand
deposits should give significant impetus to increased competition.
In some key aspects thrifts might even enjoy some competitive advantages
over banks.

Federally chartered S&Ls enjoy statewide branching privileges in

limited-branching and unit-banking states. In addition, through Remote Service
Units, S&Ls allow customers to make deposits to and withdrawals from accounts
at stores and other places away from the institution's offices. The.comoetitive
position of thrifts relative to banks is further enhanced by the 1980 Depository
Institutions Deregulation Act provision continuing the l/4 percent differential
interest rate ceiling structure for six more years.
A second development undermining the Supreme Court arguments supporting
the line of commerce view has been the sharp rise in the cost of bank funds.
The dominance of noninterest-bearing demand deposits in bank liability
structures has been steadily eroded by inflation, high interest rates, and
the resulting efforts of consumers and business to economize on holdings of
idle, nonearning cash balances. In 1960, demand deposits held by individuals,

- 17 -

partnerships, and corporations accounted for 63 percent of total bank
liabilities. This figure fell to 40 percent by 1970 and stood at only
12
31 percent in 1978.
Much of the growth in bank time and savings deposits
has taken place in negotiable certificates of deposit and other time deposits,
particularly those categories exempted from interest rate ceilings. Banks'
commercial customers have further attempted to minimize cash balances
through use of Repurchase Agreements that allow firms to earn market interest
on excess transactions balances.
Increased reliance on the Federal funds market and other categories
such as Eurodollar borrowings have also expanded the portion of bank funds
acquired under market conditions. The result has been a sharp increase in
banks' marginal cost of funds.

Since the marginal cost of funds is the

prime determinant of bank prices, competitive cost advantages banks once may
have enjoyed over nonbank competitors such as finance companies have largely
evaporated. In addition, it is not true today that finance companies rely
on bank loans as a major source of funds. These companies derive most of
their funds from the corporate debt and commercial paper markets, with bank
loans accounting for only a small portion.
Relative growth rates of savings deposits in recent years also calls
into question the Court argument that banks enjoy a "settled consumer preference"
in the competition for consumers' savings due to the convenience of maintaining
savings and checking accounts at one institution. Recognizing that competition
for the savings dollar among banks and thrift institutions had increased, a
13
1968 District Court decision
concluded that a settled consumer preference

=M arvin Goodfriend, James Parthemos, and Bruce Summers, "Recent
Financial Innovations: Causes, Consequences for the Payments System, and
Implications for Monetary Control," Economic Review, Federal Reserve Bank of
Richmond, March/April 1980.
13
U.S. vs. Provident National Bank [280 F Supp. 1 E.D. Pa. 19681.

- 18 -

no longer prevailed. Competition among these institutions, therefore, was
required to be reflected in the concentration ratios used to measure competition.
The nationwide extension of transaction accounts to thrifts suggests
these institutions may be the ultimate beneficiaries of "consumers' preference"
in the coming years.

Though NOW accounts at banks and thrifts will bear

identical yields, continuation of the interest differential on savings along
with more liberal branching authority in many states should provide a
competitive advantage for thrifts. We might expect to see a continuation or
even acceleration of growth of savings and small time deposits at thrifts
relative to commercial banks.
Finally, economic conditions, innovations in financial markets, and
new technology are breaking down traditional methods of marketing banking
services. Banking customers are more interest-sensitive than ever before
and are demanding higher yields for surplus funds.

In response, the financial

system is clearly moving toward payment of market rates for all categories
of funds. Institutions resisting this trend will experience a reduced
ability to attract customers. Government policymakers recognize that
restrictions on depository institutions' ability to pay market rates on
deposits has contributed greatly to the rapid growth of "near-deposit" market
instruments, most notably money market funds shares that reached the $80 billion
asset level by mid-1980.

These funds provide a highly liquid, low denomination

investment yielding a market return not subject to Regulation Q or deposit
reserve requirements. To a limited degree, they can even be used as transaction accounts.
In this new environment, an increasing proportion of bank business
will likely be conducted on an explicit price basis.

Customers receiving

market interest on deposits can expect to pay full-cost prices for other
services provided by their depository institutions. It may no longer be

- 19 -

feasible for firms to offer a wide range of specialized services to their
depositors free or at subsidized prices. Another force contributing to
this result is recent legislation requiring the Federal Reserve System to
charge explicit, per-unit prices for the payment system services provided
to depository institutions. These charges, by necessity, will also be passed
on to customers.
The emergence of an explicit pricing environment should contribute
to the further "unbundling" of bank products and services. Explicit pricing
may also reduce customers' costs of obtaining information about financial
services. This may reduce the importance of locational convenience in
banking relationships-especially in an electronic banking environment.
Electronic Funds Transfer Systems are reducing the importance of onestop banking. Proliferation of credit and

debit cards, preauthorized transfers,

automated teller machines, point of sale terminals, as well as continued
telephone and mail banking, expand the geographic scope of the "locallylimited" customer and increase the ability of distant institutions to provide
effective competition in local areas. As a result, increased scrutiny of
geographic as well as product markets will be required in bank consolidation
cases.

Changes in Competitive Analysis
Some disaggregation of the relevant bank product line seems necessary,
therefore, before economically relevant markets can be defined for antitrust
purposes. At the same time, significant competition from nonbank firms that
affect banks' ability to set prices and service levels must be included in
the competitive analysis. We are not suggesting total disaggregation and
examination of concentration ratios for every individual service line.

Some

- 20 -

aggregation still seems relevant. For instance, treating the consumer and
commercial (or retail and wholesale) sides of banking as separate lines of
commerce would allow an analysis of competition in the products and services
produced by institutions separated according to the types of customers that
use them. This treatment would appear consistent with the emphasis the
Court placed on customer demand characteristics in its definition of a
relevant product market in U.S. vs. DuPont.
Disaggregation and analysis of multiple product markets will require
careful evaluation of the relevant geographical markets over which customers
can "practicably turn for supplies." Clearly, the potential of electronic
banking and the possibilities of relaxing prohibitions on interstate banking
in the near future will blur geographic delineations and require an intensified
research effort in this area.
It is our belief that there is no longer sufficient justification
for excluding thrift institutions from the competitive analysis in markets
for consumer services. These institutions have now attained the status of
being fully competitive with banks.

In fact, until the interest differential

on savings and branching differences are eliminated, thrifts may even enjoy a
clear advantage in competing for consumer business. Their deposits should be
included, therefore, in the calculation of concentration ratios for antitrust
purposes.
Considering the limitations placed on the ability of savings and loan
associations and credit unions to compete for commercial business, however,
these institutions can probably continue to be excluded from the analysis
of the market for commercial services. This may not be the case for mutual
savings banks with their commercial lending and deposit-taking powers.

The

Supreme Court apparently anticipated the inclusion of these institutions as

-

competitors with banks:

21 -

"At some stage in the development of savings banks

it will be unrealistic to distinguish them from commercial banks for purposes
of the Clayton Act.

In Connecticut, that point may well be reached when and

if savings banks become significant participants in the marketing of bank
,114
services to commercial enterprises.
A disaggregation of the product line into consumer and commercial
categories would require dual analyses, possibly involving the use of an
expanded geographic market definition for business services. With this
methodology it might be possible to conclude, for instance, that a proposed
acquisition would have no significantly adverse competitive consequences
on the market for consumer banking services (based on personal deposit
market shares) while the impact on the business product line (based on
business deposits or commercial loan shares) warrants denial of the application.
The above suggestions are by no means definitive. They are viewed
merely as the minimum changes necessary at the present time to reflect
competitive reality in the marketplace. They may only represent the initial
recognition on the part of the Courts and the regulators of the evolution
underway in banking competition.

14

U.S. vs. Connecticut National Bank.