A Framework for Evaluating Potential Competition As a Factor in Bank Mergers and Acquisitions: Reply

Abstract

In his comment Framework for Evaluating Potential Competition As a Factor in Bank Mergers and Acquisitions, in the August, 1974, issue of this journal, A. J. Yeats provides a framework for the analysis of bank market structure changes with respect to potential competition. Mr. Yeats should be applauded for this effort. The empirical impact of potential competition is an area of economics that has received little analysis, yet daily regulatory decisions are being based on it. Althou« Mr. Yeats's efforts are well placed, his analysis is marred in at least two serious ways. First, his perception of what potential competition is in the banking industry is much too narrow. Second, he fails to see that the way a regulated firm reacts to potential competition is likely to be quite different from that of a firm in a nonregulated industry. Mr. Yeats suggests that the loss of one specific bank from the fringe of a bank market area represents a decrease in the intensity of potential competition in that bank market. But, economic theory implies nothing about how many potential competitors must exist for the effect of possible entrants to have an influence on the behavior of existing firms, nor is there any empirical evidence, as Mr. Yeats points out, that suggests the necessary number of potential competitors. Nontheless, looking at the issue of the necessary number of potential competitors from a practical point of view, it is not unreasonable to assume that, at least up to a point, the greater the number of potential entrants, the greater the degree of potential competition. Here we can get a bit of theoretical aid. The height of the barriers to entry in a specific industry effectively determines the number of possible competitors that could enter a market in the run. A firm producing a highly technical product, which only two other persons have the expertise to duplicate, has effectively limited its potential competitors (at least in the short run) to two. So let's look at the economic barriers to entry in commercial banking. The technology of banking is well known and readily transferable. The plant and equipment needed to begin operations are flexible, thus facilitating entry on even a very small scale. Economies associated with increasing size apparently start at a very small size and are relatively most important as size in deposits increases up to $10 million.