Financial Update (April-June 1997)

Changes in Regulation Y Streamline
Entry Into Nonbank Activities

by Keith Dozier, economic analyst in the Atlanta Fed's research department

A fter a review designed to reduce unnecessary regulation and increase efficiency, the Federal Reserve Board made significant changes in Regulation Y, which sets standards for banks' applications to engage in nonbanking activities; those changes became effective April 21. This article explains the evaluation of competitive results in nonbanking applications.

In streamlining the application process, the Board sought to reduce the regulatory burden on sound bank holding companies and to focus the review of such applications solely on the effects of the specific proposal. Comprehensive evaluations and the review of supervisory and compliance issues are to be left to the general supervisory process. Approval periods for applications and for notifications to engage in nonbanking activities have been significantly reduced in an effort to produce immediate and tangible benefits to bank holding companies.

For example, under changes in the new Regulation Y format, applicants that want to buy a going concern currently engaging in nonbanking activities may qualify for an expedited approval period of 15 days if the activity has been previously approved by the Board. Acquisitions not meeting the qualifications for expedited approval can still be approved in as few as 30 days if approval authority has been delegated to a Federal Reserve Bank. Before these changes, approval times ranged from 30 to 90 days. Approval periods, when the application is subject to Board review, will normally take 60 days but may be extended under certain circumstances.

This new ease in moving applications more quickly toward an approval decision should reduce costs associated with the application process and reduce the applicant's exposure to adverse changes in the market or business climate during the approval period.

De Novo Nonbanking Activities

The most substantive change in the new application procedures applies to bank holding companies seeking to engage in nonbanking activities de novo by entering the marketplace as a new competitor. For certain preapproved de novo activities, qualifying applicants actually have until 10 days after first starting the activity to inform the Federal Reserve (see Section 225.14, as amended Feb. 27, 1997). The list of preapproved nonbanking activities includes providing investment advisory services, real estate appraisal, the leasing of personal or real property and trust company functions, among others.

These changes reflect the view that de novo activity serves to increase the number of market producers, foster greater product accessibility and encourage competitive pricing. Competitive markets for nonbanking products and benefits to the public are among the Federal Reserve's primary concerns when considering applications to engage in nonbanking activities (see Section 225.26, as amended Feb. 27, 1997).

Questions about Competition

In contrast to engaging in nonbanking activities de novo, the acquisition of a going concern or a joint venture that engages in nonbanking activity may raise questions about competition. Just as the Federal Reserve aims to prevent significant increases in concentration in markets for bank products, this goal also applies to markets for nonbank activities. A reduction in the number of competing entities in a market increases the probability of a loss in consumer welfare.

For example, producer attrition may leave the public with limited access to nonbank goods and services. Furthermore, a decrease in the level of competition in a market may lead to a single competitor or a collusive effort by competitors to gain market power in pricing, which could hurt consumers.

Evaluating Merger Effects

The first step in evaluating the competitive effects of a nonbank acquisition or joint venture is to identify the relevant product market, its participants and the market's geographic scope. For the analysis of mergers and acquisitions between banks or bank holding companies, the Federal Reserve defines geographic local banking markets. These definitions are constantly being reviewed and, if necessary, updated. As for the definition of markets for bank products, the Federal Reserve has up to now relied upon the cluster of banking products defined in the 1963 Philadelphia National Bank case in which the Supreme Court defined the bundle of products that banks offer as demand deposits and commercial loans (see C.L. Holder, "Competitive Considerations in Bank Mergers and Acquisitions: Economic Theory, Legal Foundations, and the Fed," Federal Reserve Bank of Atlanta Economic Review 78 January/ February 1993: 23-36).

In contrast, most nonbanking activities have no such clearly defined geographic or product markets. The dissemination of different products into their respective markets requires identification of the producers of each product and a determination of the level at which they compete against one another. This process is difficult at times because there is often a lack of data relevant to nonbank products and their market participants. Geographic markets for nonbank products vary widely in scope and are a function of whether consumers purchase such products locally, regionally, nationally or internationally. For example, as cited in previous Board Orders, which can be found in the Federal Reserve Bulletin, the markets for foreign exchange and metals trading are considered to be both national and international in scope while the markets for consumer insurance products are viewed as being local.

The next step in the analysis is to evaluate the impact of a reduction in the number of competitors that may result from the merger or joint venture of two or more competitors. Often measurements of market concentration as well as other techniques are used in this analysis.

Nonbank Product Markets

These procedures, while useful, are more difficult in regard to the analysis of nonbank product markets because data relating to all of the market's competitors are typically not available. In these cases, alternative guidelines, such as a maximum postmerger market share of the largest competitor or a maximum combined market share for a predetermined number of the market's largest competitors, may be used to gain insight into the effects of a merger or joint venture in a market for nonbank products. If the market concentration measures suggest a significant impact on the competitive state of the market, then further analysis of market conditions is appropriate. Market concentration measures may provide a misleading reading of market conditions for a number of reasons. For example, a target competitor may be operating in an unsound fashion, or the market may be perceived to be attractive for entry by outside competitors in the near future.

In evaluating applications involving nonbank activities, the Board is required to consider whether adverse effects on competition are outweighed by benefits to the public, such as greater convenience and gains in efficiency.

Bankers may want to consider submitting information on major competitors in the relevant markets to streamline the review process. Alternatively, the relevant Reserve Bank can help in defining product and geographic markets. Previous Board Orders can also shed light on selected nonbank activities.

Nonbanking Joint Ventures

As opposed to mergers, joint ventures in nonbanking activities are subject to slight modifications in the application review process because of their unique nature. An acquisition or merger will remove a competitor from the marketplace. A joint venture preserves the number of competitors but involves cooperation in some areas between firms that compete in other markets. While a joint venture will not remove a provider of nonbank products from the marketplace as an acquisition would, joint ventures do give rise to serious concerns related to an increase in the possibility of collusion among firms that otherwise compete. The review of applications to engage in a joint venture to produce nonbank products includes a review of the following competitive issues:

  • the nature of the competitive relationship between the co-venturers;
  • whether or not either of the co-venturers would enter the market independently, absent the joint venture;
  • benefits to the public from the joint venture; and
  • the potential for anti-competitive tying behavior where customers of the co-venturers are forced to buy services from the joint venture or vice versa.
Continued geographic expansion, along with a wider scope of product offerings by banks, suggests that bank holding companies seeking to engage in nonbanking activities de novo or through the acquisition of going concerns will file a steady stream of applications under the revised Federal Reserve Regulation Y.
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