An Empirical Test of the Mutual Forebearance Hypothesis: The Case of Bank Holding Companies

Abstract

The 1960s and 1970s were marked by significant growth and expansion of bank holding companies (BHCs) in the commercial banking industry.' In 1956, there were 53 BHCs controlling 7.6 percent of all banking offices and 9.5 percent of all banking deposits. By 1978, however, there were 2, 113 BHCs controlling 51.8 percent of all banking offices and 66.8 percent of all banking deposits.2 Moreover, Rhoades [25] notes that the growth of BHCs throughout this period was attributable to acquisitions that expanded the geographic scope of the banking operations. The rapid growth of BHCs represented a dramatic change in the banking system and subsequently raised questions concerning the undue aggregate concentration of banking resources, the safety and soundness of the banking system, and the vigor of competition in banking markets with large, diversified BHCs present.3 In particular, the move toward acquisitions that extended the BHCs' operations into several geographic markets has drawn the attention of bank regulators and economists. One hypothesis advanced to describe the potential impact that large, geographically-diversified BHCs may have on the performance of banking markets is the mutual forebearance hypothesis.4 The hypothesis asserts that BHCs avoid competitive behavior (e.g., price cutting) in one market because they expect, or conjecture, that their rivals, whom they compete against in multiple markets, will retaliate in some other market. In other words, when BHCs compete against one another in a number of geographic markets, they may be less apt to behave competitively because of the potential for retaliation by a rival in another market. As a consequence, these potential multi-market interdependencies may have an adverse impact on performance in local banking markets.