Banking Structure and Performance in Isolated Markets: The Implications for Public Policy

• DOI: 10.1177/0003603X7201700309
• Published date: 01 September 1972
• Date: 01 September 1972
• Subject Matter: Article

BANKING

STRUCTURE

AND

PERFORMANCE

IN

ISOLATED

MARKETS:

THE

IMPLICATIONS

FOR

PUBLIC

POLICY

by

DONALD

R.

FRASER

and

PETER

S.

ROSE-

The regulatory authorities are continually called upon to make

important decisions regarding changes in the structure of the

banking industry. Applications for new banks, branches of existing

banks, mergers, and acquisitions of banks by holding companies

require that the regulatory authorities assess the impact of these

changes upon the performance of the industry and, in the process,

have some idea-perhaps only loosely

formed-of

the "optimum"

structure of banking.

The traditional assumption upon which legislation and policy

have been based is that there is an important association between

changes in the structure of an industry, or changes in competitive

conditions, and changes in the performance of firms in that

industry. Until recently, however, this assumption was, at least in

the banking industry, an hypothesis which had

not

been subject to

rigorous empirical testing.

In the last decade a number of studies have attempted to give

empirical weight to this previously untested assumption. 1

*Associate Professors of Finance at Texas

A&M

University.

The opinions expressed are those of the authors.

1See, for example, the studies of Edwards, Flechsig, Fraser

and Rose, and Kaufman. Franklin R. Edwards, "Concentration in

Banking and its Effects on Business Loan Rates," The Review

of

Economics and Statistics, XLVI (August 1964), 294-300; Theo-

dore G. Flechsig, "The Effects of Concentration on Bank Loan

Rates," The Journal

of

Finance, XX (May 1965), 298-311; Donald

R. Fraser and Peter S. Rose, "More on Banking Structure and

Performance: The Evidence from Texas," The Journal

of

Financial

and Quantitative Analysis, VI (January 1971),601-611; George G.

Kaufman, "Bank Market Structure and Performance: The Evi-

dence from Iowa," The Southern Economic Journal, XXII (April

1966), 429-439.

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928

THE

ANTITRUST

BULLETIN

Substantial progress has been made in these attempts to relate the

structure of banking to the performance of the industry. To the

extent that conclusions can be reached thus far, it seems that

changes in banking structure or in the competitive conditions of

that industry do affect the performance of individual banks, but

the impact of structural changes is quite small. Nonetheless, the

results of many of these studies are conflicting and there is little

doubt that additional empirical evidence is needed before the

regulatory authorities can be provided with meaningful generaliza-

tions upon which to base policy.

The purpose of this study is to extend our understanding of

the relationships between structure and performance in the bank-

ing industry by looking at a fairly homogeneous group of banks in

awell-defined region and by selecting a substantially larger num-

ber of performance measures than has been common to most

studies in this area. The sample was purposely restricted to small

banks in relatively isolated market areas because of the crucial, but

unresolved problem of defining the appropriate banking market.'

While

the relevant market area differs for different banking ser-

vices,

the various product markets appear to be roughly co-

terminous in the case of small communities served by relatively

small banks. Moreover, by looking at a very wide range of per-

formance measures, it is hoped the impact of structure on per-

formance will become clearer than if the performance measures

had been limited merely to the prices of bank services. Because of

the oligopolistic nature of most banking markets, prices charged

by individual banks may not adequately reflect the true impact of

banking structure. 3

2One major difficulty in defining the market area is that

commercial banks are multi-product firms and the market area for

these products may differ considerably, especially in the case of

large metropolitan banks. For a discussion of the significant

issues

see David A. Alhadeff,

Monopoly

and Competition in Banking

(Berkeley,California: University of California Press, 1954).

3Fraser and Rose found in another study that the entry of a

new bank into a small community had a substantial impact on a

number of performance measures, although virtually no effect on

the prices of bank services. Donald R. Fraser and Peter S. Rose,

"Bank Entry and Bank Performance," The Journal

of

Finance,

xxvn (March 1972), 65-78.