The Risk Effects of Bank Acquisitions

Since the early 1980s, the U.S. banking industry has seen a strong trend toward consolidation, partly because of state regulatory changes permitting out-of-state bank acquisitions. There were 6,157 bank mergers and acquisitions (M&As) between 1981 and 1994 (Rhoades [1996]). Consolidation of this magnitude has brought significant changes to the banking sector that are in themselves worth investigating. By identifying these changes, we also gain valuable information about the ongoing wave of M&As that began with enactment of the Interstate Banking and Branching Efficiency Act in 1994.1 Moreover, M&As require regulators’ preapproval, and information on the likely effects of such changes can be useful in the approval process. A prime objective of research on bank M&As has been to identify motives for consolidation. Such motives as scale economies, scope economies, and managerial X-efficiencies have been studied extensively.2 However, less attention has been given to the other two most frequently suggested motives for bank M&As: risk diversification, and the wish to become “too big (or too important) to fail.”3 The present paper contributes to the literature by evaluating the importance of the risk diversification motive. Our study considers only bank acquisitions, which differ from mergers in that the acquired bank continues to operate as an institution after being acquired; it does not lose its charter. This focus on acquisitions allows us to identify how each party—-the acquirer and the acquired bank—affects the risk of failure of the newly formed banking organization. The paper proceeds as follows: The next section discusses the importance of the risk diversification motive and defines our contribution to the related literature. Section II presents