Does it matter that to some extent banks are commonly owned?

by on January 16, 2016 at 12:24 am in Data Source, Economics | Permalink

There is now a paper on this topic by Azar, Raina, and Schmalz, the main result is this:

We document a secular increase of deposit account maintenance fees and fee thresholds with a new branch-level dataset, as well as substantial cross-sectional variation in these prices and in deposit rate spreads. We then examine whether variation in bank concentration helps explain the variation in prices. The standard measure of concentration, the HHI, is not correlated with any of the outcome variables. A generalized HHI (GHHI) that captures both common ownership (the degree to which banks are commonly owned by the same investors) and cross-ownership (the extent to which banks own shares in each other) is strongly correlated with higher maintenance fees, fee thresholds, and deposit rate spreads. We use the growth of index funds as a source of exogenous variation to establish a causal link from GHHI to higher prices for banking products.

In other words, if companies are owned by the same pension and mutual funds, why should they compete against each other?  Imagine managers given financial incentives for greater stability rather than greater risk-taking, so this does not require a publicly traceable conspiracy.

The first paper on this general question was in fact written by me and Ami Glazer about twenty-five years ago, although we never managed to get it published.  Our biggest problem was perhaps the lack of clear evidence at the time.  This is the best evidence I have seen so far, although I still file this under “speculative”…

For the pointer I thank Uri Bram.

1 3rdMoment January 16, 2016 at 12:44 am

I wonder if anyone will notice that this conflicts with very popular critiques of shareholder capitalism and alleged short-termism.

2 JThomas January 16, 2016 at 1:04 am

This has been talked about quite often by Matt Levine. He is not convinced of the argument at least as it pertains to the airline industry.

Also, as others have pointed out: bankers are not known to be uncompetitive.

3 Mark Thorson January 16, 2016 at 1:26 am

If the question is whether these commonly owned banks should be separate entities, the answer is yes. FDIC insurance only covers $250,000 total for all the accounts you have at one bank. But, for every bank you have accounts in, you get another $250,000 of coverage.

4 chuck martel January 16, 2016 at 9:07 am

That’s a big issue for almost everyone that I know.

5 Mark Thorson January 16, 2016 at 1:05 pm

Actually, it is a big problem in my family. We need to take my 88-year-old mother to another bank to open yet another account. We’re running out of local banks. If two of her banks merged, that would be a major pain in the butt.

By the way, most of her assets are in real estate. And Dad was a teacher in the California public schools from about 1966 to about 2001. Mom has excellent and cheap health care, too. The teacher’s unions (CTA and AFT) did good work in those days.

6 Daniel Hennessy January 16, 2016 at 1:53 am

Azar, Raina, and Schmalz have made the most common statistical error in the world – mistaking cause and effect. The banks did not become oligopolistic because of the institutional investment. Instead, institutions chose to invest in the banks BECAUSE they were oligopolistic. Wouldn’t you?

7 JB January 16, 2016 at 5:07 am

You’re missing a step.

1) Banks are oligopolistic for one set of reasons
2) Institutions cross-invest, creating another set of reasons
3) Now, changing the first set of reasons in order to stimulate bank competition won’t work

It’s a mechanism by which the status quo reinforces itself, interesting to students of regulatory effects

8 Thomas January 16, 2016 at 2:43 pm

Broad passive index funds don’t make those kind of decisions.

9 mulp January 16, 2016 at 1:59 am

I remember Milton Friedman et al in the 60s arguing that bank deregulation, and getting rid of Regulation Q would mean easy to get low interest loans AND checking and savings paying much more than 4% that was the legal max for just savings, and no interest allowed for checking, though banks did give away free toasters and other appliances. But also under fire was the interstate banking prohibition.

And with Reagan, they were deregulating with abandon promising that banking would be even safer than the half century with no bank runs or widespread bank failures.

Banking became so lucrative than banks gave you cars and appliances and clothes, even houses and furnishings, for taking out loans. GM and GE were profitable banks subsidizing money losing manufacturing which provided the borrower incentives.

But the US have seen two banking crisis requiring bailouts since the deregulation to make banks safer. And savings earns zero interest and checking is high fee, and not something banks want to do. And loans are extremely expensive, unless the government is backing them and setting the terms.

10 Mark Thorson January 16, 2016 at 3:00 am

I don’t think you can blame banks for savings earning near-zero interest. We live in a time of historically low inflation. It won’t last forever, but it sure seems like it.

11 rayward January 16, 2016 at 7:26 am

The marker used to be cross ties among corporate boards of director; now it’s (opaque) ownership. It’s nothing new that concentration of wealth increases financial and economic instability. What’s often overlooked is concentration of wealth among otherwise unrelated investors (i.e., mutual funds, etc.). When wealth (and, therefore, investment) is dominated by a few, the consequences can’t be good. Mutual funds had their genesis in the investment funds created by the descendants of the great industrialists of the Gilded Age: as their numbers multiplied, so did the need for a higher rate of return, which they achieved through a combination of their wealth. The mutual fund has the same goal writ large. Thus, one of the great achievements in the world of finance (the investment partnership) contains the seeds of its own (and everybody’s) destruction.

12 chuck martel January 16, 2016 at 9:05 am

“as their numbers multiplied, so did the need for a higher rate of return,”

One doesn’t follow the other. You’re simply making that up.

13 rayward January 16, 2016 at 9:29 am

Ten people living off $100 million of capital can enjoy a fine standard of living with a 5% return; one hundred can’t. History is revealing, especially about the future.

14 Hiawatha Jones January 16, 2016 at 9:57 am

Ten people, each who contributed 10 million, can enjoy a fine standard of living with a 5 percent return. 100 people, each who contributed 10 million can enjoy the same standard of living. I’m not sure you understand how mutual funds work.

15 Harry January 16, 2016 at 12:07 pm

The authors are confusing the custodial agents with the actual owners (shareholders) of the firms.

The firms they cite as owners are predominately custodial agents, acting on behalf of the actual shareholders.

The owners (shareholders) of the firms include both institutional owners (pension funds, mutual funds, etc.) and individual shareholders.

Typically, the institutional/individual ownership ratio for large cap U.S. firms ranges from 60/40 to 70/30.

Most importantly, it is not the case that “companies are owned by the same pension and mutual funds.”

Institutional owners rarely “buy the market” as index funds do.

Institutional owners work as hard as they possibly can to own the best performing assets within an asset class, and they cull their portfolios ruthlessly.

I do not believe the authors understand how competitive, and researched-based, the investment world really is, nor do they appreciate the fierce competition between the top-performing firms within any asset class.

16 Cowboydroid January 16, 2016 at 12:53 pm

Does fractional reserve banking matter to those concerned about incentives for greater stability rather than greater risk-taking?

17 jorod January 16, 2016 at 6:58 pm

Does it matter that profits attract competition?

Comments on this entry are closed.

Previous post:

Next post: