The last decade has witnessed a substantial number of mergers and acquisitions in the financial services sector of many industrial countries. This ‘merger movement’ has been documented in detail and generally discussed in various official reports and research papers. For example, it was observed that the phenomenon was particular concentrated among banking firms, that this type of consolidation accelerated during the last years of the 1990s, that most M&As occurred within national borders and that - as a consequence - many countries (e.g. Australia, Belgium, Canada, France, the Netherlands and Sweden) reached a situation of high banking sector concentration or faced a further deterioration of an already previously concentrated sector, whereas a few others (notably Germany and the United States) remained relatively unconcentrated. The origins of the ‘merger movement’ were found, interalia, in technical progress (particularly in communication technology), deregulation, general globalisation and the resulting competitive challenges for financial firms and, related to the latter, monetary integration in Europe. Of particular interest for policy makers, market participants and researchers are the consequences of such an extensive consolidation process for the efficiency and competitiveness of bank intermediation, for market liquidity and financial stability and for the working of monetary policy.

In the present paper we address some of these issues and draw some tentative policy conclusions. We provide a theoretical basis for the joint analysis of the impact of mergers on competition among banks and of their effects on individual reserve management and banking system liquidity. The Ferguson ‘Report on Consolidation in the Financial Sector’ pointed out that ‘...by internalising what had previously been interbank transactions, consolidation could reduce the liquidity of the market for central bank reserves, making it less efficient in reallocating balances across institutions and increasing market volatility’ (Group of Ten, 2001, p. 20). Although the central banks contributing to this report did not see any evidence so far that financial sector consolidation had led to this result, they agreed that the situation should be monitored carefully.