WASHINGTON — The drive to break up the big banks has won a surprising number of adherents from both sides of the political spectrum — everyone from Neel Kashkari, the Republican head of the Federal Reserve Bank of Minneapolis, to Bernie Sanders of Vermont, the Democratic socialist who has made it the heart of his campaign.
The issue is usually analyzed from a political standpoint, focusing on whether a breakup is possible and how it could be done.
But the topic raises a critical question that is seldom asked, much less answered: Is there a legitimate, coherent business case to be made for the largest and most complex banks to stay large and complex? Do megabanks serve a critical function that justifies their undeniable risk to the financial system?
The answer is, unsurprisingly, difficult to determine and varies greatly depending on whom you ask. American Banker interviewed bankers, industry representatives, analysts, reform advocates, academics and others to attempt to break down whether the presence of large U.S. banks is still necessary for the economy.
Following are the arguments over what big banks bring to the table — and a look at whether those arguments make a case for keeping the banks intact.
Megabanks bring benefits through economies of scale.
There are more than 6,000 federally insured banks in the U.S., most of which are relatively small community banks with assets in the millions or hundreds of millions of dollars. Just eight domestic institutions are considered global systemically important banks, or G-SIBs, which are subject to higher capital, liquidity and prudential requirements.
Those are: JPMorgan Chase ($2.4 trillion in consolidated assets); Bank of America ($2.1 trillion); Citigroup ($1.8 trillion); Wells Fargo ($1.7 trillion); Goldman Sachs ($880 billion); Morgan Stanley ($834 billion); Bank of New York Mellon ($377 billion); and State Street ($247 billion).
Their size enables these banks to take advantage of certain markets that are characterized by their low margin — activities like payment and clearing services, triparty repurchase agreements, prime brokerage services or custody banking. To make a profit in those markets, a bank has to be very large to take advantage of the efficiencies that come with economies of scale, enabling the banks to deal in sufficient volume.
"Instead of Boeing and Airbus, could you have a series of community airplane producers? I think the answer is no, or you could but at extremely high cost," said Greg Baer, president of the Clearing House Association and a former executive of JPMorgan Chase and Bank of America. "So as you reduce the size of the firms, you're effectively asking them to shed economies of scale and scope, and that comes with a cost."
Karen Shaw Petrou, managing partner at Federal Financial Analytics, said those activities are "fundamental to the U.S. financial markets' functioning and infrastructure," but pointed out that they could mostly be performed by smaller banks in a disaggregated system. Such an arrangement, however, would be less efficient, and therefore more expensive.
"All of the efficiencies of the G-SIBs come with added risk," Petrou said. "You would have less risk" if the banks were broken up, "but it would be at considerably less efficiency."
Petrou also noted out that many of these activities do not inherently have to be performed by banks — they could almost as easily be performed by very large private equity firms or other financial services firms. If those firms were to take up such activities, however, they would likely have to be very large in order to take advantage of the same efficiencies. A bank breakup would move the risk to another part of the economic system — but it wouldn't eliminate the risk.
Marcus Stanley, policy director for Americans for Financial Reform, acknowledged that the big banks did have economies of scale, but said there's little data to demonstrate that the largest G-SIBs need to be as big as they are to take advantage of them. Perhaps a bank would need to have several hundred billion in assets to compete in certain markets, but academic research on the subject is heavily dependent on how the research is modeled.
"Say you're a derivatives and repo dealer operating on a global scale. That's something that you have to be big to do, but these are also businesses that would have collapsed without massive public support in 2008," Stanley said. "If I'm looking at the period when I'm making money, things might look good, but if I'm looking at the period when I'm taking the public bailout, not so good."
Dennis Kelleher, president of the public advocacy group Better Markets, argued that any legitimate market function that the big banks are performing would not simply disappear if those banks were made smaller and less complex. Perhaps they would be provided at greater cost, but that cost would likely be a better reflection of external costs posed to the public by the banks' risk to the taxpayer.
"I have no doubt that if there is a service that the market wants ... that that service will be provided by somebody," Kelleher said. "Will it be provided at the exact same price? Probably not. Am I worried about that? No."