Is bigger really better?

Bank executives, Wall Street analysts, and of course, the investment bankers who advise either side in a megamerger transaction largely agree that America's banks need to become ever greater in size to be able to compete in the next century.

The conventional wisdom follows the logic of Brent Erensel, a banking analyst at UBS Securities. "Consolidation makes sense and is good. It makes the entire industry more efficient," he said. "It confers pricing power on the dominant institutions - they have larger market shares and a greater ability to control prices of their products. They also get economies of scale, and they're able to offer a broader range of products and technology."

Indeed, the belief that technological innovation may make banking as we know it irrelevant has probably done more to drive the current merger boom than any other single factor. But as the superregionals combine into ever more gigantic institutions, some wonder whether the resulting banks haven't become so large as to become unmanageable.

"It's going to be a very major problem," according to William Winter, a financial institutions consultant at McGladrey & Pullen. "At the size they were even 10 years ago, it was already a problem. It's reached that critical-mass stage. I think it's gotten to the point where there's almost paralysis."

Mr. Winter said he believes that banks with more than $10 billion of assets are vulnerable to serious management problems. "There's more of a 'them versus us' attitude between the branches and the main office rather than 'there's all of us in this together,'" he said. "Either they are going to have to come up with a nontraditional management structure, or the communication has got to be very, very strong."

James M. Marks, a bank analyst at Hancock Institutional, said he sees diminishing returns for banks at even lesser asset sizes than Mr. Winter does. His research showed that banks are too large when assets top a mere $1 billion.

"A lot of these mergers are predicated on the assumption that there are economies of scale in the banking business," Mr. Marks said. "The evidence that I have points in the opposite direction. Return on assets, for the industry broken down by size, has consistently shown that the most profitable grouping is the $100 million to $1 billion group. That has not changed. There are economies of scale in the banking industry, but they give out at a certain asset size."

Charles Cranmer, a bank stock analyst at M.A. Schapiro & Co., argued that profitability problems are not created simply because banks get to be a certain size. He said the real issue is rate of growth.

If you look back at the failures or near-failures of banks in the 1980s, he said, you see unbridled growth by acquisition, followed by increased lending and weaker underwriting in an effort to support larger cost bases.

This model was disastrous for banks like Midlantic and Bank of New England, Mr. Cranmer pointed out. "There are diseconomies of scale in banking, as well as economies. The diseconomies are closeness to the customer and credit quality."

Ronald I. Mandle, a banking analyst at Sanford C. Bernstein & Co., uses Citicorp as an example to make the same point. During the 1980s, he said, Citicorp had a "hands-off" management style that resulted in massive credit card losses, problems with highly leveraged transaction loans, and cratered real estate investments worldwide.

"The job of management is to set direction and have very good controls," Mr. Mandle said. "We see large industrial enterprises being run, so it certainly can be done right. But size isn't a guarantee."

Some management consultants said the biggest problem with megamergers is their negative impact on customer service.

As banks get bigger, top management is necessarily further and further removed from revenue-generating clients, from the point of sale, so to speak. This can be remedied by insuring the organization is imbued with a sense of banking as a service business, said direct marketer Robert Wilcox of New York-based Wilcox & Associates.

"Big is not necessarily bad as long as it's reengineered to be responsive. Some organizations do better than others at extending the corporate ethos down into the rank and file. Barnett, NationsBank do a particularly good job of that," Mr. Wilcox said. "That is an opportunity that awaits with the megamergers."

Of course, some observers, like Christopher Flowers, who co-heads Goldman, Sachs & Co.'s financial institutions investment banking practice, say: "Bankers are absolutely able to manage these larger units."

As proof, he pointed to foreign banks like HSBC Holdings PLC and Deutsche Bank, which have larger branch systems than some of the U.S. superregionals, yet manage to report solid returns.

Lawrence Vitale, a banking analyst at Bear, Stearns & Co., said Citicorp's current results and its impressive turnaround in the mid-1990s are also a strong counterargument against skepticism about size.

But Keefe, Bruyette & Woods Inc.'s James McDermott warned that the industry is in "an evolutionary stage with respect to management skills. Today's managers cut their teeth managing considerably smaller entities. How are these managers going to take on the problems larger organizations present? This is the question for the next 10 years."

He did, however, point out that there is hope for the current crop of bank executives. "Today's managers have technology and a wealth of data base information to make good decisions about customers, products, and profitability," he said, but that's not the way it was 20 years ago.

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