Bank Mergers and the Dynamics of Deposit Rates Ben R. Craig and Valeriya Dinger ECB Conference October 20, 2008

1. Bank Mergers and the Dynamics of Deposit RatesBen R. Craig and Valeriya DingerECB ConferenceOctober 20, 2008

2. This presentation does not reflect the views of the Federal Reserve Bank of Cleveland nor does it necessarily reflect the views of the Board of Governors of the Federal Reserve System nor the views of the Deutsche Bundesbank. They are solely the views of the authors.

3. The Big Question:

4. The Big Question: • How do changes in market structure modify firm pricing behavior?

5. The Big Question: • How do changes in market structure modify firm pricing behavior? • Specific to banking: how do changes in local deposit market structure (caused by bank mergers) affect interest rate dynamics?

6. Well maybe we had better first talk about the data and then get back to the “question”….

7. Data • Weekly deposit rate series for 781 banks in 164 local markets from 1997 to 2006 (Bankrate Monitor) • Weekly (quarterly) data on bank balance sheet and income statement variables (call report) • Yearly controls for the characteristics of local markets (summary of deposit) • Merger data 1988-2005 (In a sense, daily) • Daily price data on national rates.

8. Data • Weekly deposit rate series for 781 banks in 164 local markets from 1997 to 2006 (Bankrate Monitor) • Weekly (quarterly) data on bank balance sheet and income statement variables (call report) • Yearly controls for the characteristics of local markets (summary of deposit) • Merger data 1988-2005 (In a sense, daily) • Daily price data on national rates.

9. Data • Weekly deposit rate series for 781 banks in 164 local markets from 1997 to 2006 (Bankrate Monitor) • Weekly (quarterly) data on bank balance sheet and income statement variables (call report) • Yearly controls for the characteristics of local markets (summary of deposit) • Merger data 1988-2005 (In a sense, daily) • Daily price data on national rates.

10. Data • Weekly deposit rate series for 781 banks in 164 local markets from 1997 to 2006 (Bankrate Monitor) • Weekly (quarterly) data on bank balance sheet and income statement variables (call report) • Yearly controls for the characteristics of local markets (summary of deposit) • Merger data 1988-2005 (In a sense, daily) • Daily price data on national rates.

11. So we can address dynamics And yet use a lot of cross-sectional variation.

12. Like a real treasure hunt… • In addition we have will have weekly data on loan rates to retail consumers. • Data on subordinated debt. • Daily stock market price data. • And so on, all being matched up.

13. One could get real expansive here… But let’s return to the problem at hand.

14. The Big Question: • How do changes in market structure modify firm pricing behavior? • Specific to banking: how do changes in local deposit market structure (caused by bank mergers) affect interest rate dynamics?

15. The Big Question: • How do changes in market structure modify firm pricing behavior? • Specific to banking: how do changes in local deposit market structure (caused by bank mergers) affect interest rate dynamics? • Banking is a good laboratory: good data, local markets, substantial variations in market structure across markets and across time

16. The Big Question: • How do changes in market structure modify firm pricing behavior? • Specific to banking: how do changes in local deposit market structure (caused by bank mergers) affect interest rate dynamics? • Banking is a good laboratory: good data, local markets, substantial variations in market structure across markets and across time • Lots and lots of markets and lots and lots of banks

17. Background • The impact of market structure on prices has traditionally been the focus of industrial organization. Most empirical studies are performed in a static framework • The research interest in the dynamics of price changes has mainly been motivated by the role of sticky prices in the monetary policy transmission • The waves of mergers and acquisitions in various industries have encouraged research interest in the dynamics of market structure

18. Background • The impact of market structure on prices has traditionally been the focus of industrial organization. Most empirical studies are performed in a static framework • The research interest in the dynamics of price changes has mainly been motivated by the role of sticky prices in the monetary policy transmission • The waves of mergers and acquisitions in various industries have encouraged research interest in the dynamics of market structure

19. Background • The impact of market structure on prices has traditionally been the focus of industrial organization. Most empirical studies are performed in a static framework • The research interest in the dynamics of price changes has mainly been motivated by the role of sticky prices in the monetary policy transmission • The waves of mergers and acquisitions in various industries have encouraged research interest in the dynamics of market structure

20. Empirical literaturePrice inflexibilityin banking • Due to better data availability and homogeneity of the “product” most banking studies concentrate on deposit rather than loan rates • Berger and Hannan (1991): positive relation between price rigidity and market concentration. Estimate only the probability of a downward (upward) change, not the speed of adjustment. Find evidence for the asymmetry of price adjustments • Neumark and Sharp (1992): deposit rates are sticky and stickiness is asymmetric (banks are slower to increase deposit rates than to decrease them). Use a switching model that jointly estimates the probability and the magnitude of a deposit rate change. More concentrated markets exhibit stronger asymmetries • Mester and Saunders (1995): the prime rate is asymmetrically sticky • These studies assume that market structure is static

21. Empirical literature Change in market structure and prices • Broad literature on the pricing effects of mergers. Most studies concentrate on bank mergers because of data availability (another extensively studied industry is airlines) • In-market-mergers: • Hannan and Prager (1998): study deposit rate changes after a merger (+12 months), find out that in-market-mergers result in lower deposit rates—no controls with monthly data. • Focarelli and Panetta (2004): expand the time horizon after the merger (+36 months), include various controls and challenge the results of Hannan and Prager. Deposit rates decline shortly after a merger but recover later on. Three years after a merger the merged bank offers relatively higher deposit rates than prior to the merger. Argue that this result is caused by increased efficiency being passed through to consumers

22. This paper • replicates earlier research approaches on a new dataset • presents a new empirical approach for estimating bank mergers’ impact on deposit rate dynamics

23. A problem in the literature… • Some find that mergers increase deposits rates these find that increased efficiencies are passed on to the consumer. (Hannan and Prager, 1998) • Others find that mergers decrease deposit rates these find that monopoly rents are extracted from consumers. (Focarelli and Panetta, 2004)

24. What are the differences? • Differences time periods of data • Different time horizons of analysis • Differences in countries (Italy vs. US) • Differences in focus (out of market vs. in-market mergers) • Differences in types of banks in the data set

25. Empirical literature Change in market structure and prices • Out-of-market mergers: • No research on the dynamics of price changes after out-of-market-mergers • The effects of out-of-market-mergers have been estimated in a static framework in studies of the impact of multimarket banks’ presence (Hannan and Prager, 2004; Park and Pennacchi, 2005). These studies show that multimarket banks offer lower deposit rates after a merger.

26. Our Stand on this • We assume that both in- and out-of-market mergers have an impact of prices, and we account for both types of mergers. In fact the distinction between the types of mergers is not so clear in our data.

27. Set of mergers • Distinction between in- and out-of-market mergers Market B Market A

28. Set of mergers • Distinction between in- and out-of-market mergers • … is not so clear in our data Market B Market A

29. Set of mergers • Distinction between in- and out-of-market mergers • … is not so clear in our data Market B Market A • Include all bank mergers but control for what they change

30. We • Study the dynamics of market structure changes and price changes • Estimate the impact of bank mergers on deposit rate while also looking at the inflexibility of the deposit rates. • How do deposit market structure changes affect: • the magnitude and direction of price changes? • frequency and direction of price changes? (for another paper)

31. Static framework- The effect of bank and market characteristics on deposit rate level Results are consistent with theoretical predictions and the results of previous studies

32. Dynamics of deposit rates changesDeposit rate changes after a merger: the impact of time horizon • A year after the merger (as in Hannan and Prager (1998))

33. Result are close to Hannan and Prager’s: mergers have a negative impact on deposit rates

34. Dynamics of deposit rates changesDeposit rate changes after a merger: the impact of time horizon • But what about the long-term effect? Focarelli and Panetta (2004) argue mergers need a longer period to produce efficiency gains

35. Reproducing Focarelliand Panetta Results change substantially, mergers appear to have a positive impact on deposit rates.

36. Alternative models short-term long-term Hannan and Prager - - no controls ln(ratet/ratet-1) + - ln(ratet/ratet-1) controls + Focarelli and Panetta + ratet-3montht-bill dependent

37. So the difference between Hannan et al and Focarelli et al is in the time horizon and controls. The difference between our results and Penacchi and Park is that we have a richer sample of banks.

38. Now that we see that our data is consistent with the past…. • A new empirical framework including: • Deposit rate rigidity • Richer merger definition

39. Empirical literaturePrice inflexibility • Carlton (1986): documents price inflexibility for a number of consumer goods; points to a positive correlation between market concentration and price inflexibility • Caucutt, Ghosh and Kelton (1999): document variation in price inflexibility across commodity goods, argue that durability in addition to sellers’ concentration contribute to price stickiness • Bils and Klenow (2004): argue that prices more flexible than generally assumed. Underline the variation of price stickiness across goods. Argue that the response to monetary policy may deviate from the predictions of Calvo models

40. Price Inflexibility One Bank’s example

41. Price Inflexibility One Bank’s example 3 month T bill (green) Fed Funds (yellow)

42. Price Inflexibility One Bank’s example Money Market rate (blue)

43. Price Inflexibility One Bank’s example Checking Account Rate (red) Money Market rate (blue)

44. Price Inflexibility Another Bank’s example

45. Price Inflexibility Another Bank’s example Note again the asymmetry of response

46. Price Inflexibility Another Bank’s example Note again the asymmetry of response

47. Frequency of Rate Changes

48. Our model: Dependent variable: Standard controls

49. Our model: Merger splines: knots at ½ year prior to the mergers, at the merger date, ½ year, 1, 1 ½, 2, 3 and 4 years after the merger (based on [-1, 10] years data) -.5 Merger date .5 1 1.5 2 3 4 -.5 Merger date .5 1 1.5 2 3 4 t t

50. Our model: • Merger controls: • change of bank size • change of market share • change of number of markets