“Too big to fail” alive and well in U.S. banking

By Rob Cox
November 23, 2010

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

What happened to ending “too big to fail”? That was one objective of the U.S. financial reform bill passed earlier this year. Central to the Dodd-Frank Act were rules designed to make big banks less exciting and safer, along with the creation of an authority designed to smoothly wind down even the largest institutions without massively disrupting the financial system.

Five months after the bill’s passing, big banks should have lost at least some of their funding advantage over smaller rivals. But as the latest quarterly report from the Federal Deposit Insurance Corp shows, too big to fail is still alive and well.

There’s no perfect measure of this effect. But buried in the regulator’s quarterly data dump is a line, entitled “cost of funding earning assets,” which comes as close as it gets. It is, in any event, the statistic the FDIC’s own honchos, including Chairman Sheila Bair, use to assess the issue.

The figures show that U.S. banks with more than $10 billion of assets — of which there are 109 — paid an average annual interest rate of around 0.8 percent to their depositors. Meantime, the country’s 7,651 smaller banks paid on average 1.29 percent a year on deposits.

True, that’s a narrower gap than in the third quarter last year: 0.49 percentage point, against a 0.69 percentage point difference then. But looked at another way, large banks are, on average, paying nearly 40 percent less than their smaller brethren. Expressed that way, the advantage is virtually unchanged from a year ago.

That suggests that depositors, whose cash is the cheapest and most stable funding for banks, still believe their money is safer in the vaults of the biggest banks — so safe they are willing to be paid meaningfully less than if they parked their money with community banks. That in turn implies a belief that the biggest banks won’t be allowed to fail.

Maybe that will change as the details of Dodd-Frank are hammered out and communicated to the public. But the more likely scenario is that the profitability of small banks will continue to be squeezed, forcing many of them to sell to bigger banks. The unlucky ones will simply remain small enough to fail.


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‘Too big to fail’ can be a significant issue where individual large incompetent and/or corrupt institutions fail and then cause a domino effect by collapsing other well run companies. This was not the case in the current financial crisis which was the result of a systemic fallacy believed by all institutions – namely that there would never be a widespread decline in a key asset category like housing. If there had been a larger number of smaller organizations; then ‘too big to fail’ would just have become ‘too many to fail’.

Posted by walstir | Report as abusive

After the last election, the details of Frank/Dodd will be hammered out under the direction of the same party that insisted removing the bank tax from the original bill.

Too big to fail will remain a problem well into the future.

Posted by breezinthru | Report as abusive