Federal Reserve Bank of San Francisco

FRBSF Economic Letter

1999-25 | August 20, 1999

More Economic Letters

A New View on Cost Savings in Bank Mergers

Simon Kwan and James Wilcox

Over the past decade, the banking industry has undergone rapid consolidation. Before the 1990s, most bank mergers involved banks with less than $1 billion in assets; more recently, even the very largest banks have merged with other banks and with nonbank financial firms.

Globalization, technological advances, and more regulatory flexibility are often cited as factors that have stimulated and allowed more banks to merge. Banking organizations involved in mergers almost always point to cost savings and diversification as motives for merging. Mergers may reduce costs if banks can close redundant branches or consolidate back-office functions. Mergers may also further diversify bank portfolios and thereby reduce the probability of insolvency, thus allowing merged banks to cut costs further, because their borrowing costs and capital-asset ratios are lower.

One of the most striking aspects of the recent wave of bank mergers has been the split between bankers and economists about the practical importance of these cost advantages to merged banks on average. The managements of merging banks and industry analysts often project sizeable cost reductions, typically to be achieved by reducing labor and physical capital inputs. Economists in universities and in bank regulatory agencies have been hard-pressed, however, to identify systematic merger-related gains in bank productivity. For example, Berger (1998) concurred with the results and views of many economists that bank mergers on balance have had little effect on banks’ total noninterest costs. Pilloff and Santomero (1998) surveyed both the statistical and case study literature on bank mergers. Based on their reading of the enormous empirical literature on bank costs, they concluded that on average the market valued the combined firm no higher than it did the separate components. Had merging cut costs, higher total market value would have been anticipated.

This Economic Letter reports on our study (Kwan and Wilcox 1999), which takes a new look into the cost savings argument. Our view is that the conventional analyses typically have underestimated a number of sizeable and long-lasting cost reductions that merged banks have achieved. Underestimates of cost reductions stem from merger accounting rules that trigger accounting adjustments that bias reported costs upward. The rules of purchase accounting require marking the purchased bank’s assets to market, often resulting in increases in the accounting values of both physical and intangible bank assets. As a result, post-merger banks report higher depreciation and amortization charges on their larger asset bases, even if they own and operate the same buildings and equipment after a merger as they did before a merger.

Accounting issues

Currently, according to Generally Accepted Accounting Principles (GAAP), there are two methods to account for business combinations: purchase accounting and pooling-of-interests. In purchase accounting, all the assets of the target bank are marked to market before they are combined with the acquiring bank’s assets, including the target bank’s premises and equipment. The difference between the purchase price and the revised book value of target bank’s equity, after marking all the target bank’s assets to market, are recorded as goodwill, an intangible asset, in the surviving bank’s book. All intangible assets then must be amortized and expensed per GAAP. Hence, in purchase accounting mergers, both the stock value of bank premises and the stock value of intangible assets for the surviving bank would likely be higher than those of the combined total of the acquirer and target before the merger due solely to purchase accounting. If the recorded bank premises and intangible assets are marked up due to the use of purchase accounting, the surviving bank’s reported depreciation charge and amortization expense will rise instantly, even if the surviving bank changes nothing after the merger.

In pooling-of-interests, the target bank’s assets, liabilities, and owners’ equities are combined with those of the acquiring bank at book value as though the two companies had always been commonly owned. Thus, the reported assets of the merged bank would be equal to the sum of the reported assets of the two merging banks, absent any real changes in bank assets after the merger. Hence, unlike purchase accounting, pooling-of-interests would not trigger additional depreciation expenses or goodwill charges. However, the merging banks must satisfy all the conditions for pooling, including certain pre-merger attributes, such as comparable size, and post-merger activities limiting assets sales or stock repurchase; otherwise, the purchase accounting method must be used.

Figure 1 shows that the percentage of purchase accounting bank mergers was rising during our study period, and Figure 2 indicates that the average ratio of market value to book value equity for banking companies also was rising. Both of these trends are likely to raise the reported expenses more during the latter part of the study period than during the earlier part. To minimize the distortions and obtain a more accurate measure of the change in genuine operating performance of a merged bank that used the purchase accounting method, we adjust the merged bank’s reported premises expenses and other noninterest expenses by the amount that is attributable to the purchase accounting revaluations.


We compile data for a sample of over 1,000 of the bank mergers that occurred between 1985 and 1997. We then compare the post-merger ability of merged banks to cut costs with the cost-cutting achieved over the same period by banks that did not merge. About one-third of the sample mergers used purchase accounting.

Without first adjusting the data for the purchase accounting effects, we find that merged banks (relative to non-merged banks) cut their total noninterest expenses by economically small and statistically insignificant amounts. Of the three operating cost components, labor costs, which are not affected by purchase accounting revaluations, registered the largest drop after the merger, falling an average annual amount of 0.02% of total assets. Unadjusted premises expenses and other noninterest expense, however, on average went up after mergers.

Purchase accounting triggered significant incremental premises expenses and incremental intangible expenses. Adjusting premises expenses and intangible expenses shows that merged banks on average did cut occupancy and other noninterest costs, suggesting that bank mergers have produced operating cost savings. On average, merged banks cut annual total noninterest expense by 0.04%. So, for a merged bank that earns, say, a 1% return on assets (ROA), these average cost savings translate into a 4% increase in ROA.

The adjustment for amortization expense rose over time and was largest in recent years. This reflects the fact that purchase premia over the book values of target banks were rising over time (see Figure 2). After adjusting for accounting revaluations, bank mergers in 1993-95 shaved adjusted total noninterest expense by 0.1% of total assets, which is equivalent to a 10% boost in an ROA of 1 percentage point.

More recent bank mergers were found to cut operating costs more than earlier bank mergers. However, mergers involving large banks cut costs neither more nor less than mergers among smaller banks. Nevertheless, the evidence weakly supported the idea that the operating performance of large mergers, relative to their smaller counterparts, seemed to be improving over time.


Do bank mergers lead to operating cost savings? While the majority of past research did not find significant cost reduction after banks merged, bank managers and banking consultants cite improving operating cost efficiency as a primary motivation for bank mergers.

The purchase accounting method can trigger additional reported occupancy expense and amortization expense by the surviving bank that have nothing to do with actual costs. Hence, to measure the changes in performance before and after the merger more accurately, our study adjusts the reported data to eliminate the pure accounting effects on reported costs. In addition, we also include more recent data in our analysis, so that we cover a period when the banking industry was financially much stronger and the pace of banking consolidation was rapid.

We find evidence that bank mergers have reduced operating costs. Both labor costs and occupancy expense are found to decline significantly after the merger. However, some of these findings are evident only after we remove the pure accounting effects on reported expense data, confirming that merger accounting can hide a significant portion of cost cuts. While the evidence is stronger for the more recent time period, we also find that the size of the merger did not have a significant effect on the amount of cost savings.

Simon H. Kwan
Senior Economist

James A. Wilcox
Professor of Finance,
UC Berkeley, and
Visiting Scholar, FRBSF


Berger, Allen N. 1998. “The Efficiency Effects of Bank Mergers and Acquisition: A Preliminary Look at the 1990s Data.” In Bank Mergers & Acquisitions, eds. Yakov Amihud and Geoffrey Miller. Kluwer Academic Publishers.

Kwan, Simon H., and James A. Wilcox. 1999. “Hidden Cost Reductions in Bank Mergers: Accounting for More Productive Banks.” Federal Reserve Bank of San Francisco Working Paper 99-10.

Pilloff, Steven J., and Anthony M. Santomero. 1998. “The Value Effects of Bank Mergers and Acquisitions.” In Bank Mergers & Acquisitions, eds. Yakov Amihud and Geoffrey Miller. Kluwer Academic Publishers.

Opinions expressed in FRBSF Economic Letter do not necessarily reflect the views of the management of the Federal Reserve Bank of San Francisco or of the Board of Governors of the Federal Reserve System. This publication is edited by Sam Zuckerman and Anita Todd. Permission to reprint must be obtained in writing.

Please send editorial comments and requests for reprint permission to
Research Library
Attn: Research publications, MS 1140
Federal Reserve Bank of San Francisco
P.O. Box 7702
San Francisco, CA 94120