Small Banks Will Suffer from Big-Bank Breakups
Viewed through the framework provided by the economist Nassim Taleb, a centrally directed financial system with uniform risk management and prescribed products is fragile.
Safety and soundness in banking will be found more in changes in oversight than regulation.
Some people assume that when big banks lose, community banks win. I'm not convinced. In fact, I think we need to be careful what we ask for. How can you potentially rip apart institutions that hold more than 50% of the industry's assets without having a significant negative impact on banks in general and the economy as a whole?
Consider how a government-mandated big-bank breakup would play out in the marketplace. Just one of the largest institutions could devolve into a dozen or more superregionals. Those superregionals would make a direct play for the kinds of small business, agricultural and commercial real estate loans that are the bread and butter for banks like mine. That redistribution of customers would play out all of the way from the largest to the smallest. The customer universe gets pretty small at the bottom.
The "resized" banks would still enjoy economies of scale. This disruption in the banking industry also opens up another door for tax-exempt credit unions and Farm Credit System institutions.
The government's deeper reach into private industry – even if focused on the largest banks – also could harm banks of all sizes in other ways. Investors already are wary of banks' growth prospects due to all of the new rules and regulations. Attracting capital will be that much harder once Uncle Sam has established his rights to further manage the business of banking. Investment dollars are fluid and there are a lot of options outside of our industry. Bank multiples are significantly impacted by publicly traded valuations and those multiples flow downstream to non-publicly traded community banks as well.
Policymakers clearly don't want to harm small banks, but it's difficult to see how they can insulate us from the macroeconomic effects of some of the proposals being considered. The recently-leaked Brown-Vitter approach, for instance, would require all banks to hold a minimum 10% ratio of tangible equity to total consolidated assets with an additional surcharge of 5% for banks with more than $400 billion in assets.
Getting there from here would require the industry to raise $1 trillion in new capital or offload more than $3 trillion in loans and other assets in order to right-size banks to the new capital requirements, according to an analysis by the American Bankers Association. That's the equivalent of booting a majority of banks out of the economy while they bring their ratios in line. Again, this impacts all banks, not just large banks.
Just as importantly, what does that disruption do to economic growth and all whose livelihoods are dependent on a continued recovery? The March unemployment numbers reminded us again that the recovery is still fragile. Who will take up the slack when banks are sidelined? Foreign banks? Or perhaps the less-regulated shadow banking industry, birthplace of some of the "innovations" that caused the last financial crisis?
I truly understand the anger that is fueling some of the "too big to fail" debate. And I wholeheartedly agree that TBTF is patently unfair and has to end. But a rational discussion is what's needed if we are to avoid a cure that is as bad, or even worse, than the disease. I actually think the current debate is healthy and positive. We will eventually get to solutions. But now it's time to start actually applying facts and studies to the potential solutions being bantered about.
We've already experienced the outcome and ramifications of abruptly passed legislation. For those of us in the community banking space, remember when we were told that Dodd-Frank would primarily impact large banks? Strike one. Remember when we were told that the Consumer Financial Protection Bureau would only impact those with more than $10 billion in assets? Strike two. Now there is this assumption that breaking up big banks will only impact big banks. How do you call this pitch? From my perspective it has a significant chance to be strike three for community banks, big banks and our industry as a whole.
So let's be careful what we wish for. Let's find solutions that first do no harm to the recovery and the economy in general. Second, let's bring about positive change for community banks and the banking industry as a whole. These changes should move the entire industry forward in a safe and sound matter, truly address TBTF and support and grow our communities, our customers and our economy. We can't afford to get this one wrong.
Plagge is president and CEO of Northwest Financial Corp., a $1.5 billion community bank holding company in Arnolds Park, Iowa.