The “Risk-Adjusted” Price-Concentration Relationship in Banking

Elijah Brewer III and William E. Jackson III
Working Paper 2004-35
December 2004

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Price-concentration studies in banking typically find a significant and negative relationship between consumer deposit rates (i.e., prices) and market concentration. This relationship implies that highly concentrated banking markets are “bad” for depositors. It also provides support for the Structure-Conduct-Performance hypothesis and rejects the Efficient-Structure hypothesis. However, these studies have focused almost exclusively on supply-side control variables and have neglected demand-side variables when estimating the reduced form price-concentration relationship. For example, previous studies have not included in their analysis bank-specific risk variables as measures of cross-sectional derived deposit demand. The authors find that when bank-specific risk variables are included in the analysis the magnitude of the relationship between deposit rates and market concentration decreases by over 50 percent. They offer an explanation for these results based on the correlation between a bank’s risk profile and the structure of the market in which it operates. These results suggest that it may be necessary to reconsider the well-established assumption that higher market concentration necessarily leads to anticompetitive deposit pricing behavior by commercial banks. This finding has direct implications for the antitrust evaluations of bank merger and acquisition proposals by regulatory agencies. And, in a more general sense, these results suggest that any Structure-Conduct-Performance-based study that does not explicitly consider the possibility of very different risk profiles of the firms analyzed may indeed miss a very important set of explanatory variables. And, thus, the results from those studies may be spurious.

JEL classification: L11, L21, L40, G21, G28

Key words: structure-conduct-performance, efficient-structure, consumer deposit pricing, risk-adjusted, commercial banks

The authors thank Robert Eisenbeis, Robert Connolly, Timothy Hannan, David Ravenscraft, Stephen Rhoades, Richard McEnally, Kathryn Moran, and participants at the UNC-Chapel Hill Finance Seminar Series for helpful comments. They also thank Nuray Güner for excellent research assistance and Sam Peltzman and Allen Berger for encouragement to pursue this line of research. Jackson gratefully acknowledges the financial support of the National Science Foundation. The usual disclaimers apply. The views expressed here are the authors’ and not necessarily those of the Federal Reserve Banks of Atlanta or Chicago or the Federal Reserve System. Any remaining errors are the authors’ responsibility.

Please address questions regarding content to Elijah Brewer III, Research Department, Federal Reserve Bank of Chicago, 11th Floor, 230 S. LaSalle Street, Chicago, Illinois 60604-1413, 312-322-5813,, or William E. Jackson III, Federal Reserve Bank of Atlanta, Research Department, 1000 Peachtree Street, N.E., Atlanta, Georgia 30309, 404-498-8708,, and The Kenan-Flagler Business School, University of North Carolina at Chapel Hill.