Large Banks Improve Competition and Consumer Choice in Local Markets

20 May 2019
Read Time 6 mins
Categories :
Value of Large Financial Institutions

In the past 30 years, large companies such as Walmart, Target, and Home Depot have transformed the U.S. economy.  At the national level, large companies represent a growing share of all commerce, which has contributed to a view that large firms dominate the economic landscape at the expense of smaller companies and consumers.  New research by economists from Princeton University and the Federal Reserve, however, shows that the increasing presence of large, national companies at the local level has actually reduced local market concentration and enhanced consumer choice.  In this post, we demonstrate that this finding extends to the presence of Financial Services Forum member bank branches.  Specifically, since the 1990s, local markets where Forum members have opened branches have become less concentrated and offered more banking choices to consumers.  What’s more, the total number of bank branches available to consumers in those local markets increases.  Accordingly, as is the case in a range of other industries, as Forum members have entered local markets, they have coexisted alongside existing banks while enhancing competition and broadening consumer choices.

Accordingly, as is the case in a range of other industries, as Forum members have entered local markets, they have coexisted alongside existing banks while enhancing competition and broadening consumer choices.

The research paper referenced above uses firm-level data covering the U.S. from 1990 through 2014 to document that across a wide range of industries, local market concentration has declined.  Market concentration is defined with respect to the Herfindahl-Hirschman or “HHI” concentration index applied at the zip-code, metropolitan, and county levels.  The HHI measure is defined as the sum of squared market shares among all companies in a local market (zip code, or city, or county).  If one firm has a 100 percent market share, then the HHI is 10,000 and if a large number of companies all maintain an equal market share then the HHI will tend to zero as the number of firms increases.  The HHI measure is a well-accepted measure of market concentration that is used by the Department of Justice and other federal regulators to gauge market competition.  Markets with a lower HHI are less concentrated, more competitive and more favorable to consumers.

Forum Member Entry into Local Markets and Market Concentration

The main finding of the research paper is that local market concentration has declined across a range of industries since the 1990s.  Specifically, Figure 1 (reproduced from the paper) shows that average market concentration in local markets, where a local market is defined by a zip code, has declined across a range of industries.  Importantly, the researchers show that the “FIRE,” or finance, insurance and real estate sector, has exhibited one of the most significant downward trends in local market concentration since the 1990s.  Also, the authors convincingly show that across a range of industries, the decline in concentration is driven by the increasing presence of large, national companies.  Specifically, they show that as large, national firms enter a market, they increase the total number of companies in the local market and thereby reduce concentration and increase competition.

The focus of this research on local market concentration is important.  As the authors rightly point out, “all markets are local.”  In assessing market concentration, it is important to focus on an area that can credibly be viewed as a “market.”  Since most people shop and compare products in a limited geographic area, considering a “national market” is of limited relevance to most consumers.  Also, while e-commerce and internet shopping are clearly more important today than they were 25 years ago, much commerce is still conducted in brick-and-mortar establishments within a limited geographical area.  In the case of banking, much has been written about the continued importance of local bank branches.  In particular, Federal Reserve researchers recently wrote a research note outlining the continued importance of local bank branches.

In Table 1, we extend the results of the paper to local market concentration in bank branches by computing local market concentration in all local markets as well as those markets where a Financial Services Forum member opened a branch.  We use FDIC Summary of Deposits data to compute market concentration in local market deposit shares.  In our analysis, we use both 1994 and 2010 as beginning dates and 2018 as the end date of our analysis.  We consider both 1994 and 2010 as the beginning dates for our analysis because the composition of the banking sector changed so much over the 1994-2010 period.  We consider local markets at the zip code, city, and county level to ensure that we consider a wide range of local markets.

Source: FDIC Summary of Deposit Data, available at https://www.fdic.gov/open/datatools.html

As shown in Table 1, markets where a Forum member opened a branch typically exhibit a sharper average decline or a smaller average increase in concentration than observed across all local banking markets.  While it is the case that market concentration increased slightly more at the county level between 1994-2018 (one case), in every other market and time period (5 cases), markets in which a Forum member opened a branch exhibited a sharper decline or a smaller increase in market concentration than that observed across all local markets.  As an example, at the zip code level, between 1994 and 2018, local markets in which a Forum member opened a branch saw a roughly two percent decline in concentration while all local markets exhibited roughly a five percent increase in concentration over the same period.  When local markets are measured at the city level and the analysis begins in 2010, markets experiencing entry by a Forum member exhibited roughly a 12 percent average decline in concentration while all local markets exhibited roughly a 10 percent increase in concentration over the same period.  Overall, the results in Table 1 comport with the broader findings of the research paper.  Entry by Forum members into local markets has reduced market concentration and enhanced consumer choice for banking services.

Table 2 provides more evidence on how the entry of large banks in local markets improves competition and consumer choice.  Specifically, Table 2 reports the average percentage increase in the number of branches in markets where a Forum member opened a branch versus all local markets.  Consistent with the results in Table 1, markets where a Forum member opened a branch typically experienced a larger increase in the total number of branches than was observed in all local markets.  As was the case in Table 1, the county-level results over the 1994-2018 period show that the increase in branches is roughly the same across all markets and markets where a Forum member opened a branch.  In all other cases, however, markets where a Forum member opened a branch exhibited stronger growth in the number of bank branches.  As an example, at the zip code-level and over the 1994-2018 period, markets in which a Forum member opened a branch experienced roughly a 78 percent increase in the number of branches as compared with an overall increase of roughly 17 percent across all local markets.  At the city level over the 2010-2018 period, markets in which a Forum member opened a branch exhibited roughly a 60 percent increase in branches while all markets experienced roughly a 15 percent decrease over this period.  This finding is also consistent with the broader findings of the research paper and is important for dispelling a common misconception that large companies (and large banks) enter a market and then drive out local incumbents.  These data reject that view.  While it may be the case that entry of large banks in a local market causes some firms to exit, on the whole, local markets see a net increase in the total number of branches as a result of the entry of large firms.  This increase benefits consumers through increased choice, competition and reduced market concentration (as measured by HHI).

Source: FDIC Summary of Deposit Data, available at https://www.fdic.gov/open/datatools.html

Conclusion

A recent research paper finds that, across a wide range of industries, local market concentration has declined, which has improved consumer choice and competition.  Moreover, the research finds that this trend is driven by the increasing presence of large, national companies in local markets.  We extend this finding to the case of bank branches and show that the entry of Forum member bank branches into local markets has reduced market concentration and improved competition and consumer choice.  These results are important for understanding how large banks contribute to the competitive landscape as well as the overall U.S. economy.

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