As we near the anniversary of Lehman's bankruptcy, there will be much discussion about whether the financial sector is safer or whether we failed to learn the lessons of the crisis. We can certainly debate whether new regulation has done enough, gone too far in certain areas, or hits the right spot. But what is not debatable is that things in the financial sector and, specifically, large U.S. banks, have changed, and they have changed for the better.
In the aftermath of the crisis, three main things were clear: large banks were too leveraged; regulators were ill-equipped to deal with the scale and scope of the crisis; and if markets expected large banks to be bailed out, bondholders would provide cheaper funding to large banks, giving them an unfair competitive advantage. However, progress has been made on all three of these fronts, and we've also tackled other critical financial issues outside of "too big to fail."
Since 2008, the banking sector has raised nearly $450 billion in capital to protect against potential losses and the six largest U.S. banks raised $290 billion in capital, a 67% increase. It is also greater than the amount of Troubled Asset Relief Program funds injected into the entire banking system. With these increases in capital, large banks are significantly less likely to fail. In fact, in the most recent round of stress tests, the six largest U.S. banks maintained an average Tier 1 capital ratio of 8.2%, well above the 5% minimum requirement.
Regulators have also worked to ensure that if a large bank were to fail, they have new tools to better understand how to wind it down to avoid future bailouts. Banks' living wills provide the blueprint, while the Orderly Liquidation Authority gives regulators new legal tools to wind down a firm while minimizing costs to the broader economy.
More work is needed in this area, but evidence from markets suggests the government's commitment to letting a large bank fail is real. Bond prices suggest bondholders are pricing in the possibility of failure as large banks now are at a funding disadvantage to their smaller peers. Further, Moody's and Standard and Poor's have stated that large banks are less likely to be bailed out in the future.
But while the TBTF debate is important, the crisis extended beyond banks. Money market funds, mortgage brokers and other nonbank financial companies ran into significant problems. Off-balance-sheet entities such as hedge funds caused problems at firms like Bear Sterns. And our regulatory system simply did not cover these entities. That is no longer the case. Systemically important nonbanks will be subjected to a prudential regulator. Derivatives contracts are more transparent and require margin and liquidity requirements. And all institutions are subjected to new, enhanced rules to guard against counterparty risk.
The financial sector is undoubtedly safer, but it is also more competitive. Much discussion about bank size paints a picture of large banks growing uncontrollably, but my research suggests our economy is becoming less dependent on large banks. Large bank holding companies' market share, measured by share of industry assets, has fallen from 68% to 63% since the passage of Dodd-Frank. While crisis mergers led to a one-off jump in the size of large banks, in the past several years growth in banking assets has concentrated in regional banks, not large banks, increasing competition among the two groups.
The argument that nothing has changed is just factually wrong. Since Lehman, many changes have been made to our financial sector. More debates will come about the specifics surrounding capital, the Volcker rule, regulation of community banks, and cross-border derivatives. But with the general push for more capital, liquidity, regulatory knowledge and tools, the financial sector is safer and more competitive.
Patrick Sims is the director of research at Hamilton Place Strategies, a policy consultancy based in Washington.