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Are Big Banks Necessary?

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."

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Wayne is spot on. Markets, businesses and consumers ultimately decide these matters the correct way. The Bigs are already simplifying their models, deleveraging and spinning off non-bank entities. They are big, they will most likely stay big, but they are and will become less complicated when it is all said and done. When the government gets involved and picks winners and losers, we get things like billion dollar tax exempt credit unions and the mission creep/tax free-loading Farm Credit System. How is that working out for community banks? Our industry better find some unity soon or we'll see our individual and collective market shares high jacked at an even more intrusive level than we are seeing today by politicians and bureaucrats.
Posted by NWIowa Banker | Thursday, March 10 2016 at 4:52PM ET
The main question of the article is not hard to answer at all, and it is being answered every single day, by the hundreds of millions of bank customers. They choose which banks they want to do what they want done, in what variety and form. Their answer is an unambiguous one: we like the wide variety of bank models and sizes that are offered to us; what we don't want we stop doing business with. The idea that any group of Washington experts can decide that question within the realms of reality would be laughable if it weren't so dangerous for the wellbeing of the myriad of bank customers who through their own choices prefer to answer the question for themselves. Perhaps of equal importance, those bank customers will be constantly changing their answers as their needs change and bank offerings adjust or don't adjust to meet customer needs.
Posted by WayneAbernathy | Wednesday, March 09 2016 at 10:26AM ET
Megabanks bring diseconomies of scale in that they impose a social cost on us -- financial crises. They do more to evade risk, liquidity and capital regulations than any other financial entities.

They aren't necessary to the economy, in that smaller banks and other entities acting as groups can do the same things.

That's why it makes a lot of sense to impose graduated capital requirements that penalize size. Let the banks grow as big as they like, but let them pay for it, because they raise our risks.

Or better still, hand banking regulation back to the states, as it is for insurance. They regulate better than the Feds, and besides, if you love JP Morgan, Citi, Bank of America, and Wells Fargo as much as I do, you will love having 51 of them even more.
Posted by djmerkel | Wednesday, March 09 2016 at 8:48AM ET
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