Regulatory Incentives and Consolidation: The Case of Commercial Bank Mergers and the Community Reinvestment Act
Bank regulators are required to consider a bank’s record of providing credit to low- and
moderate-income neighborhoods and individuals in approving bank applications for
mergers and acquisitions. We test the hypothesis that banks strategically prepare for the
regulatory and public scrutiny associated with a merger or acquisition by increasing their
lending to low-and moderate-income individuals in anticipation of acquiring another
institution. We find evidence in favor of this hypothesis. In particular, we show that the
higher the percentage of the institution’s mortgage originations in a given year that are
directed to low- and moderate-income individuals or neighborhoods, the greater the
probability that the institution will acquire another bank in the following year. Further
investigation bolsters the view that this correlation is due to banks’ anticipation of the
public and regulatory scrutiny during the merger review process. The effect cannot be
explained by other bank characteristics. The relationship is observed for acquiring banks,
which are the focus of public and regulatory scrutiny, but not for the banks that are being
acquired. In addition, the positive effect of lending to low- and moderate-income
individuals and neighborhoods on the likelihood that a bank will acquire another bank
increases over the 1991 – 1995 time frame, a period when public and regulatory scrutiny
of an institution’s community lending record increased. The effect of lending to low- and
moderate-income individuals and neighborhoods is also largest for big banks, who face
particularly intense public and regulatory scrutiny.