Three things are driving the growth of large banks: market demand, access to capital and regulatory burden. Failing to consider these in the rush to break up "too big to fail" banks could force critically important financial services to move offshore or to less stable nonbank competitors.

Ideally, the size of a bank should correspond to the size of the businesses and number of people it serves. Community banks are best suited to serve small businesses and local communities. They cannot handle the needs of large multinational corporations. 

A large international bank is needed to do that. Outlaw large banks in the U.S. and many international companies will move their business to London or another major global banking center. Whatever we do about the size issue, serving the market must be a first priority. If only a large bank can serve a certain market segment, then we need to figure out how to live with them. They may be hard to regulate, but better we regulate them than another nation. 

Another reason large banks have grown is that they have unimpeded access to capital while smaller banks face a number of hurdles attracting institutional investors. The culprits are the Bank Holding Company Act and now the Volcker Rule.

Diversification is a cardinal rule of investing. The activity restrictions in the BHCA and the investment restrictions in the Volcker Rule effectively prohibit any entity that owns more than 5% of the stock of a bank holding company from engaging in any activity not closely related to banking.

That isn't a problem for a large bank. It would take many billions of dollars to acquire 5% of Chase or Citi so investors in those banks never become subject to these restrictions. But it is a real problem for a small and medium size bank.  Many institutional investors have internal guidelines requiring investments to be above a certain size that exceeds 5% of many banks. So most institutional investors only invest in large banks. This needs to be corrected for smaller banks to be viable.

These restrictions separately and together strongly favor shell holding companies with no ability to support the bank if it is in trouble and makes a mockery of the Source of Strength Doctrine. Citi and Chase can be a source of strength and supply capital to their banks when needed to grow. Other banks can only grow with the bank's retained earnings. This is one of the main reasons why banks' share of the credit markets has declined while the role of shadow banks and the securitization markets has steadily grown over the past 50 years.

The final factor is regulatory burden. The number of regulations has grown to a size where compliance requires large and highly trained staffs. This has nothing to do with the merits of the regulations, just the sheer volume. Large banks can hire those people, but small banks increasingly struggle.  It has been estimated that Dodd-Frank alone could add more than 20,000 pages of new regulations.  That will be compounded by Basel III, the Card Act, new mortgage regulations, etc. One or two people in a small rural bank cannot keep up with this.

These issues don't sync up with the political debate so they are largely ignored, but they are nonetheless real and fundamental to the whole issue of "too big to fail." As long as they are buried in the political blather don't be surprised to see the big banks grow bigger while smaller banks atrophy and less stable, unregulated nonbank lenders increasingly dominate the credit markets.   

George Sutton, a former Utah commissioner of financial institutions, is an attorney at the law firm of Jones Waldo in Salt Lake City who represents banks, banking trade associations and serves as a bank director.