Myths About the Banking System Pollute Public Discourse
As someone who has worked in the trenches, I am concerned about how frequently I hear the following misconceptions about banking. The more these errors are embedded in public opinion, the less likely are fruitful discussions or prudent actions to remedy banking's ills.
1. Bank and thrift failures are due to fraud by management.
The vast majority of bank and thrift failures have not involved fraud. The real culprits behind bank and thrift failures have been excessive interest rate risk; the Tax Reform Act of 1986, which destroyed real estate values; brokered deposits; poor regulation and supervision, especially the failure to close insolvent institutions promptly; and the bankruptcy laws. Focusing on fraud shifts the blame from those who actually caused the problem: Congress, the administration, and poor bank managers.
2. Big banks are safer than small banks.
Data actually show that small local banks are better capitalized and more profitable than big banks. Big money-center banks may in fact be dinosaurs that will be forced out by their warm-blooded, smaller competitors. The concept that a few huge nationwide banks offering a financial supermarket of services have less risk of failure is pure supposition with little empirical support.
3. There are big savings to be gained by consolidation or combining the "overcapacity" in the banking system.
Today's technology permits small institutions to operate with the same efficiency as large institutions. In fact, big banks do not operate at lower expense levels than their smaller counterparts. Most bank expenses change with the bank's volume of business. Economies of scale continue to decline as banking technology improves. Merger economies occur only when good managers apply superior management skills to the combined institutions, not by "economies of scale."
Who truly believes that banks will become significantly more efficient when they become vastly larger? Will there really be fewer accountants, lawyers, and other staff?
4. The Federal Deposit Insurance Corp. has a fund to protect depositors.
Congress has already spent every dollar collected by the FDIC on guns, ships, schools, etc. Whenever the FDIC spends money on a failed institution, the Treasury must borrow the money.
Since there is no "fund," the FDIC cannot be insolvent. FDIC liabilities are liabilities of the federal government.
5. Examiners can discover problems in banks before the banks fail.
Virtually every financial institution that has failed was given a clean bill of health by bank examiners before it went into the tank. Much-better-paid accountants, investment bankers, lawyers, and in many cases, the bank's management couldn't find the problems either.
Examiners can, however, identify banks that have already failed and close them. They can also pass regulations that slow growth and limit the exposure to credit and interest rate risks.
The easiest way to identify a bank headed for trouble is to look for fast growth, big out-of-market loans, and large interest rate risk.
6. Reducing deposit insurance coverage will save money.
I don't believe the FDIC has allowed any depositor of a failed bank (with more than $500 million in assets) to lose $1, regardless of the amount of the deposit. "Too big to fail" really means insurance on all deposits, and "too big" is really a fairly small bank.
7. There is not enough capital in the banking system.
There is plenty of capital in the banking system. It has just been leveraged to the hilt through institutional borrowings with diminishing returns. Those who practice core banking -- generating consumer deposits -- have plenty of capital. To a significant degree, capital is earned, not raised. Those who aren't earning it can't raise it.
8. Old-fashioned banking is a buggy-whip business, and you can't make a profit in it.
Old-fashioned banking is still the most profitable. Institutions, large and small, that earn a profit do so by raising core deposits from local markets, prudently lending to local consumers and businesses, keeping expenses low, charging fees, and avoiding fast growth as well as exotic new products.
9. Big loans to big companies are safer than small loans to individuals or small companies.
Small companies and consumers give a banker collateral, the value of which can be analyzed along with the prospects of the customers. It's impossible to analyze the prospects of a customer with a 10-pound 10-K annual report.
10. Raising capital standards for banks and thrifts will reduce failures.
Numerous institutions with "solid" capital levels have failed because of bad loans, fast growth, interest rate risk, and so on. If 20% of an institution's assets are uncollectible, it doesn't matter whether capital is at a 3% or 4% level. Regulations limiting credit and interest rate risks, and quick action to close failed institutions will reduce the incidence and cost of bank and thrift failures.
Mr. Cooper is chairman of TCF Financial Corp., Minneapolis, and of the Association of Financial Services Holding Companies.