Third Quarter 1998 / Issue 12 (originally published by Booz & Company)

The Value of Big in Banking

The widely awaited arrival of $100 billion public financial services companies in the United States has now come to pass, albeit more quickly than most anticipated.

The mega-mergers that led to the creation of Citigroup and the new BankAmerica have raised questions about the benefits of size and whether size and scale will be necessary attributes to compete successfully in financial services as the millennium approaches. After all, consumers long ago thumbed their noses at "one-stop shopping" in banking -- at least in the way it has been offered to date. And bigness in the banking industry has not historically yielded the expected economies of scale or scope.

Nonetheless, more such mergers are likely. High stock prices, a great deal of strategic ambition and the nagging sense that there are a limited number of mega-franchises to go around are factors that will surely drive more transactions, some well advised and some not. This industry consolidation, however, raises several fundamental questions:

Is big better?

What is the value of size?

Can big be managed?

Are smaller banks marginalized by this activity?


In order to address these questions, some perspective is helpful. The United States has long been "overbanked." Even now, after 20 years of consolidation, more than 9,000 banks remain. That is down from 12,000, but is still many more than in all other industrialized nations combined. 

The 1990's have been a golden age for banks. Despite the huge numbers of commercial banks, and a rash of mergers and acquisition activity, bank equity has grown dramatically -- the result of a very favorable credit cycle, significantly lower loan loss provisions and consolidation-driven efficiency gains. (See Exhibit I.)

Still, the rise in bank capital has not been matched by a commensurate rise in loan opportunities. Instead, the top banks grow largely by acquisition. Again, conditions have been ideal -- stimulated by high stock prices, easing of banking regulation and refinement of M&A technique. The results have been striking:

Industry consolidation and concentration of power.

The rapid evisceration of the securities industry as an independent sector.

The first national bank -- the new BankAmerica.

The first universal retail bank -- Citigroup.

The rise of the financial services conglomerate.


Despite the dramatic consolidation in numbers, the United States banking industry has not yet realized the benefits of scope and scale at a company-wide level. The evidence is compelling:

Efficiency ratios have shown marked improvement during this consolidation, but the improvement has not benefited the big banks more than others.

The benefits of scale and scope have been observed in individual businesses (for example, in securities processing and the credit card business, respectively), but these relationships have still not materialized at the firm-wide level -- there is little correlation of size with returns.

Indeed, little evidence of the benefits of bigness exists despite these widely held theories about economies of scale and scope:

Size is necessary to overcome ever-larger spending requirements for branding, distribution and technology.

Scope benefits will emerge from cross-selling more products to the same customers.

Simple operating leverage can result from spreading corporate overhead across a larger operating and revenue base.

To date, the benefits of size at the company-wide level have been undone by the organizational complexity of running multi-line businesses. The challenge for the newly created mega-firms is to overcome this complexity, along with tackling the industry-wide problems associated with product proliferation and the inability to "cross-sell" additional products to existing customers. Product costs and specialization have significantly increased as a portion of banks' total expenses, but the technology and sales management practices to fuel higher cross-sell have not materialized.


Currently, the primary value of "big" depends on a bank's position against the scale requirements for each business in which it competes. These requirements drive size at the business level, however, and not across the entire firm.

A second size advantage will develop if the newly formed financial groups create technology and/or branding strategies that benefit the entire firm. A first mover can lock out other competitors by creating scale "overlays," e.g., a national brand strategy.

Finally, a third advantage of size is purely related to financial engineering -- bigger companies with higher price-to-book ratios have the ability to take out smaller companies.

Needless to say, bank C.E.O.'s need to pay attention to all three factors -- if they can surmount the third and stay in the game, the first two are the fundamentals they will need to compete.


With recent mergers, some banks have risen to the ranks of true financial "conglomerates." There has been little success to date, however, with financial supermarkets or with mergers that have linked commercial banks with investment banks.

The task now before the industry is to translate high-level statements of strategic intent into actions that yield tangible competitive advantage -- along with premium stock prices. Much of the benefit is likely to center on using technology to develop and improve distribution channels, and
in building broad-based consumer brands that increase customer awareness, usage and loyalty.

Equally critical, these new mega-firms will need to be managed in a significantly different manner than most are today. The requirements for success include:

Recognizing that distinct businesses need to be benchmarked against focused "pure-play" competitors.

Ruthlessly tracking market standing and cost positions in each competitive sector.

Explicitly tracking cross-subsidization and cost-sharing among business units as well as the incremental benefits resulting from "overlay" strategies across businesses.

A final challenge to the mega-firms is not to confuse the economics of their pure-play businesses with the economics of firm-wide overlay strategies. The returns from investment in these strategies will become the yardstick for judging whether the mega-combinations are ultimately worth more than the sum of their individual parts. If not, these firms are likely to unravel as quickly as they were created.


Much has been written about the imminent extinction of the regional bank. In fact, the merger wave is, in a sense, purely Darwinian -- the biggest or the strongest (in terms of price-to-book ratios) are likely to survive. Most of the regionals are neither the biggest nor the strongest. The standouts are those that have built focused business systems and have grown rapidly and been rewarded with high price-to-book ratios.

Examples include MBNA and Capital One in credit origination; Northern Trust in the high net worth segment; and Bank of New York and State Street Bank in securities processing. Only a few multi-line banks -- such as U.S. Bancorp, Norwest, Fifth Third, Star and First Tennessee -- make it into this high-performance category. (See Exhibit II.)  

All of these high-performing regional banks have been competing on the basis of pure efficiency gains from merger-induced cost reduction. However, having a great efficiency ratio is a necessary but not sufficient condition for long-term survival. They now need to utilize this greater efficiency to invest in revenue-generating capabilities. For instance, many need to build customer-targeting models and to develop technology to increase their success at selling additional products to existing customers.

Though it is late in the game, banks concerned about their size must review their business portfolios and ask several fundamental questions:

What businesses am I in and do I have needed market position/scale in each one?

What needs to be rationalized in my portfolio?

What needs to be reinforced?

Where do I need to upgrade or add new capabilities?

What can I do to communicate my distinctiveness?

We believe that there are three focused, strategic endpoints in this journey:

Specialize in specific customer segments.

Focus on the distribution or "retailing" of products and services.

Specialize and build volume and scale in a single business -- become a "category killer."

Given the current "feeding frenzy," tactically navigating through these shark-infested waters may prove the greatest challenge to reaching one of these strategic endpoints. Those who do not wish to be eaten may have to move quickly to a focused position by reorganizing their portfolios and building scale in a narrower range of businesses and customers.

Peter C. Davis, Peter C. Davis, a vice president with the banking and capital markets group at Booz-Allen & Hamilton, specializes in banking strategy, governance and organizational structure. He has led numerous assignments for leading money center banks, investment banks, capital markets firms and brokerages.
Atul Kamra, Atul Kamra, a senior associate with the banking and capital markets group at Booz-Allen, specializes in wholesale banking strategy and organizational effectiveness.
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