The Federal Reserve Board is considering a new and potentially more restrictive approach to evaluating bank merger proposals.
The change, which central bank officials said is in the discussion stage, could make it more difficult for banks to combine their operations or could force merging institutions to divest more branches and deposits in order to win Fed approval.
If adopted, the policy would mark a departure from the Fed's historical reliance on deposits to measure the level of competition in a market. Changes in deposit market shares were seen as an indicator of a merger's effect on an array of services, including consumer savings, small-business lending, and mortgages.
Under the proposed system, the Fed would examine how a merger affects competition in each of a bank's lines of business.
Industry observers said the current system allows a merging bank to dominate one business line and still win Fed approval.
"Anytime you have the pulling apart of individual components, you have a better chance of finding anticompetitive effects," said Thomas Greco, associate general counsel at the American Bankers Association.
The Justice Department, which asserts antitrust jurisdiction in bank merger cases, has been focusing its attention on small-business markets, where borrowers typically rely on local institutions for credit. When Wells Fargo & Co. sought permission early this year to acquire First Interstate Bancorp, the department required that 61 branches with $2.5 billion of deposits be divested to ensure adequate small-business competition.
The Fed's staff has completed a memo addressing the benefits of the proposed changes, according to Michael Greenspan, a partner at the Washington law firm of Thompson Coburn. Fed officials declined to discuss any communications between the staff and the board of governors.
"We have decided to revisit this issue," Fed Governor Janet Yellen said in an interview. "But we have not decided to change anything."
"This is something under discussion," said Fed Governor Edward W. Kelley Jr. "There have been no decisions and no deadlines."
Mr. Greenspan said he expects the Fed to be even tougher than the Justice Department on small-business lending because several Fed economists have concluded that the recent wave of mergers has hurt competition in that sector.
"This would be very bad," Mr. Greenspan said. "All you have to do is find one product market where there is a problem and you get a problem for the whole transaction."
But not everyone is worried.
H. Rodgin Cohen, a partner at the New York law firm Sullivan & Cromwell, said the change could make life easier for banks. No longer would institutions be subject to different tests by the Justice Department and the Fed, he said.
Richard Whiting, general counsel of the Bankers Roundtable, a trade group representing big banks, said any policy shift could cut both ways. Some institutions with geographically extensive operations would not be affected, he said. But those concentrated heavily in their local markets could run into trouble.
Regardless, Mr. Cohen said the Fed should move beyond this debate to consider giving more weight in market analyses to thrifts and nonbank competitors. The Fed now counts 50% of thrift deposits in calculating the competitive effect of a merger, and nonbank operations are largely ignored.
The current policy arose from a 1963 Supreme Court decision that defined the "cluster of banking services" as a range of retail products. While the Fed has followed that standard ever since, lawyers have said the central bank also has the authority to consider a merger's impact on small-business lending and other business lines.
Mr. Kelley said the board began questioning its approach in 1992, although the real impetus for the current review did not come until Ms. Yellen and Alan Blinder joined the Fed in mid-1994.
Mr. Blinder, who left as vice chairman in January, said in an interview Tuesday that he is concerned the Fed doesn't understand the impact of bank mergers on small businesses.
He warned of a drawback to the new approach: The Fed will have trouble collecting lending data on the communities affected by the hundreds of mergers that have to be evaluated each year.
The Fed staff paper, which may be completed next month, is expected to address how the agency will obtain this information.
Competition is not the only factor the Fed must consider in a merger. Among other things, it must review the Community Reinvestment Act compliance and managements' ability to lead the larger organization.
