In a recent BankThink, Independent Community Bankers of America President Camden Fine claimed a new study by the Federal Reserve Bank of New York proves that the issue of "too big to fail" remains a "persistent and burgeoning problem." Let's examine this issue more closely.
The NYFRB study relied on outdated data from a 20-year period ending in 2009, at the height of the financial crisis: a period of explicit government support for the industry and prior to the passage of the Dodd-Frank Act. Since then, Dodd-Frank, a host of regulatory initiatives and industry-initiated reforms has transformed market conditions for firms large and small. Crisis-era and pre-Dodd Frank data is about as relevant to what's going on in today's financial markets as teletype.
Even as he relied on outdated data, NYFRB researcher João Santos found only a small cost of funding advantage for large banks. He also conceded that this advantage could have nothing to do with market expectations of bailout: "To the extent that the largest banks are better positioned to diversify risk because they offer more products and operate across more businesses (something not fully captured in their credit rating), this wedge could explain part of that difference in the cost of bond financing."
For similar reasons, Wal-Mart and Apple can borrow more cheaply than neighborhood retailers or tech startups. Investors do not assume that Wal-Mart or Apple will be rescued if they fail. For investors to see large, diversified banks as a safer bet is not unreasonable. During the financial crisis, 70% of the banks that relied on the Federal Reserve's Term Auction Facility were under $50 billion in assets.
The International Monetary Fund recently examined funding advantages using more recent data 2011 and 2012 and found that any market advantages provided to the large banks at the height of the financial crisis have declined sharply to close to zero only 15 basis points.
Recent research from Oliver Wyman found that any advantage was "statistically insignificant (i.e. it cannot be confidently distinguished from zero)." These findings are consistent with credit analysts, who have been removing large U.S. banks' ratings "uplift" because they do not see an expectation of any future taxpayer bailout, believing instead that bank creditors will suffer losses if a firm gets into trouble in a future crisis.
This progress towards ending "too big to fail" in the U.S. is especially encouraging, because as the IMF data makes clear, we are well ahead of other international jurisdictions in our reform efforts. In parts of Europe, the recent sovereign debt crisis has left many bond investors with the impression that national authorities still stand behind their financial institutions. To put this in perspective, the implied borrowing advantage for some large European banks is six times the size of the advantage for U.S. banks nearly 90 basis points. That number stands in stark contrast to the U.S. and is consistent with the expectation of future government support still seen in the Eurozone.
Both the IMF and the NYFRB studies recommend that authorities around the world move to complete the existing reforms, especially cross-border resolution planning and capital requirements. However, they also warn against capping bank size or curtailing bank activities, which would have significant negative consequences for liquidity and the efficiency our economy. While our international counterparts are still working through these challenges, many of these reforms have already taken place or are underway here in the U.S.
The facts make clear that, in the U.S., the era of "too big to fail" is fading into the rearview mirror. For the U.S. economy to work its best, we need a vibrant and diverse banking sector that includes large global banks, regional banks and community banks. Banks today are safer, sounder, more secure, transparent, accountable and performing their critical roles in the global economy. Rather than picking winners and losers, we need to support a system that works for everyone.
Rob Nichols is president and CEO of the Financial Services Forum.