Can consumers shrink banks?

By Felix Salmon
April 16, 2009

Reader Steve Santini emails to ask:

I am a big proponent of the idea that if something is to big to fail, it is too big to exist. I am also a big fan of the idea that the large banks need to be broken up, in addition to regulated further. However, I feel that the government is powerless to do this. Probably because they lack the ability and courage to do so. But what about the market. It occurred to me recently that in a theoretically free market the customer is the counterforce which acts against gross accumulation of power. If customers were to take their deposits from the large banking institutions and place them in cooperative banks and small regional banks, this would have the same affect of leveling the playing field. What are your thoughts on this matter? Big banks offer pitiful interest on money that they lend and they charge exorbitant fees which contribute significantly to their profit, so it does not even make sense to do business with them (although I understand the advantages – more ATM’s, theoretically more services, etc.)

It’s a great idea, but I’m not sure it’s likely to work, for a number of reasons. For one thing, America’s biggest banks generally got that way through acquisition, rather than growth. It’s all well and good banking with a smaller bank, but when that smaller bank is taken over by a larger one, are you really meant to go through the hassle of switching banks all over again?

What’s more, having a large deposit base is certainly a nice thing for any large bank to have, but it’s not necessary. Many banks fund themselves in the wholesale market rather than through deposits, and although that leaves them open to a lot of funding risk, Treasury and the Fed have repeatedly proved themselves willing and able to step in and make sure that they will act as the liquidity provider of last resort to any bank which is having difficulties funding in the wholesale market.

Finally, the obvious place to move one’s money is a credit union. I’m a huge fan of credit unions — I even sit on the board of one — but thanks to the effort of the banking lobby, credit unions are highly constrained in where and how they can operate. Any given American probably has a choice of no more than two or three credit unions they’re allowed to join, and many are allowed to join no credit unions at all which offer a remotely acceptable degree of accessibility and convenience.

So one way to bring down the power of the big banks would simply be to allow credit unions to accept deposits from anybody, rather than only from tightly-defined fields of membership. But the chances of that happening, right now, are precisely zero. In the meantime, the whole credit union system, and especially the smallest and most important credit unions, is teetering on the brink, thanks to the fact that highly responsible lenders, which have proved themselves able to underwrite loans so well that their default rates are very low, are being forced to bail out a small group of highly-irresponsible “corporate” credit unions, which don’t even have individual members, and which lost billions of dollars on mortgage-backed instruments.

The fact is that if the government isn’t going to force the banks to shrink, there’s nothing that consumers can do about the phenomenon of too-big-to-fail banks posing an enormous systemic risk to the economy. It’s out of our hands: it’s all up to Tim Geithner, the former CEO of the New York Federal Reserve. Whose shareholders are the largest banks in America. So don’t expect too much in the way of banking-sector shake-ups from him.

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