America’s too big to fail just keep getting bigger

By Rob Cox
August 23, 2011

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

To hear the Federal Deposit Insurance Corp tell it on Tuesday, the American banking industry is returning to fine fettle. The number of institutions on the agency’s problem list fell for the first time in nearly five years. Bank failures are down. Loan books even grew slightly. So, the crisis in America’s financial system is officially coming to an end.

Yet although in aggregate the industry looks in better shape than it has been for several years, the reality is more complicated. America’s biggest banks are indeed recovering nicely. But they are doing so at the expense of the country’s thousands of smaller institutions.

Consider the FDIC’s latest statistical data dump. The country’s 106 banks with assets of more than $10 billion increased their share of industry assets to a record 79.1 percent. That has made them more efficient and allowed them to grow their earnings some 20 percent faster than smaller banks in the second quarter.

A higher concentration of banking assets is not necessarily a problem. America shouldn’t really need 7,513 banks to efficiently allocate credit to businesses and consumers. Canada, for instance, does it with just a handful. But it does create some hazards that, if not effectively dealt with, are problems.

First, America’s smaller banks are still the primary providers of capital to small businesses, which are in turn the main engine of job creation. Fewer banks dishing out less credit to small businesses is hardly an ideal recipe for bringing down the country’s 9.1 percent unemployment rate.

Secondly, as big banks increase in size, so does the potential damage to the economy and the government’s finances in the event of their failure. And that in turn increases the chances that policymakers and regulators become less inclined to actually let them fail and turn instead to moral hazard-ridden bailouts — just what recent reforms were supposed to prevent.

This too-big-to-fail menace is clear in the FDIC’s figures. The small fry are paying, on average, almost 50 percent more than the largest banks for deposits that fund their loan books. This gap makes it easier for the big to outrun and poach from the small. That may gussy up the industry’s headline numbers — but not without some risk.

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