The effects of market power on bank performance

From 2006 to 2011, a period that covers the global financial crisis and U.S. recession, around 13 percent of the community banks maintained the highest supervisory rating, with no quarter-over-quarter change in their composite CAMELS ratings during that time period. The authors study the distinguishing features of community banks that maintained the highest supervisory ratings during the recent financial crisis (2006 to 2011).  One factor that is correlated with this success was the impact of market power, as measured by the proportion of all in-market deposits controlled by a particular bank. Our findings show that differences in market power result in statistically and economically significant differences the performance and in the choices made by community banks.  At the same time, when other performance measures are taken into account as control variables, market power does not provide statistically significant explanatory power in a supervisory ratings downgrade model.  While the purpose of this study is not to argue for or against monopoly power for community banks, we do believe that the financial crisis creates an opportunity to study market power and its effects on banks and on bank performance. We also believe it gives us a chance to explore some of the trade-offs banks must make in order to expand their product and service offerings in existing markets without running afoul of competitive issues.  Further, we believe our work could provide some insight as to the continued efficacy of measuring market power by deposit share as technology continues to change the way consumers access financial services and develop relationships with financial services providers.