Review of Industrial Organization 20: 81–98, 2002.
© 2002 Kluwer Academic Publishers. Printed in the Netherlands.
Structure and Proﬁtability in Banking Markets
STEVEN J. PILLOFF and STEPHEN A. RHOADES
Federal Reserve Board, 20th and C Streets NW, Mailstop 149, Washington, DC, 20551, U.S.A.
Abstract. We use the structure-performance model and regression analysis to investigate a number
of analytical issues that often arise in evaluating competition in connection with bank mergers and
that are generally relevant to mergers in other industries. Perhaps our most consistent and strongest
ﬁnding is that the local market HHI is positively and signiﬁcantly related to proﬁtability. We also ﬁnd
that the number of organizations and the level of recent deposit growth may provide some additional
information on the level of competition. Finally, several variables including market size, the number
of large banking ﬁrms, deposits per ofﬁce, and resident migration rates exhibit similar relationships
to proﬁtability in the bivariate analysis, suggesting that there may be some characteristic associated
with market size, density, or attractiveness that is important for competition.
Key words: Antitrust, banking, competition, market structure, mergers.
The structure-performance paradigm continues to be a useful tool for investigating
practical policy and economic issues. The paradigm is fundamentally consistent
with economic theory and has provided the basis for uncovering important “em-
pirical regularities” such as the relationship between concentration and both proﬁts
In this paper, we use the structure-performance model to investigate a
number of analytical issues that often arise in evaluating competition in connection
with bank mergers and that are generally relevant to mergers in other industries.
In addition, the analysis provides a straightforward test of the concentration-proﬁts
relationship. The factors in this analysis, besides the market Herﬁndahl–Hirschman
index (HHI) include: (1) the number of ﬁrms in a market, (2) the disparity of market
shares of market participants, (3) the number of ﬁrms with a substantial market
share, (4) the importance of large ﬁrms, (5) market size, (6) market growth, (7)
deposits per ofﬁce, (8) per capita income, (9) statewide HHI, and (10) a measure
of switching costs.
The views expressed in this paper are the authors’ and do not necessarily reﬂect those of the
Board of Governors or its staff. We would like to thank Erik Heitﬁeld for helpful comments, Paul
Tan and Charles Taragin for excellent research assistance, and Cecilia Tripp for valuable typing.
For a thoughtful overview of the structure-performance paradigm and coinage of the term
“empirical regularities”, see Schmalensee (1989). As applied to banking, see Hannan (1991). The
continuing usefulness and adaptability of the paradigm is suggested by Barla (2000) and Claycombe