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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15 comments so far

Why should we care about a big bank which finances itself in the money markets. We protect banks to protect depositors, and if a large bank has no deposits, let it go.
My chief concern re small banks in the US is what happens when you are out of the region. For that reason I favor having one state nationalised bank which takes deposits , buys safe assets (government bonds) and provides checking services. it would operate much like the post office banks (Gyros)in Europe. No-one is required to bank with this institution, but anyone who chooses to go elsewhere takes a risk and, if the institution fails, must pay the price.

Posted by tomrus | Report as abusive

How do you square your proposal to open credit unions to all with their favored tax status?

I’m not a big bank fan but at the same time I don’t think they or smaller community banks should have to compete on an unequal playing field.

We don’t need to force the banks to shrink, just make it harder for them to get too big. Since the impact of a bank’s failure is exponentially proportional to its’ size (i.e., it’s not linear, as there are more downstream effects, otherwise we wouldn’t have bailed out AIG, BofA, and Citi), the cost of hedging the risk of failure will be greater, and that cost should be borne by the banks that get huge. It’s negative feedback, unlike the positive feedback (bigger bank, economies of scale -> getting bigger) that is the driving force in the economy.

Posted by KenG | Report as abusive

The size of the bank is far less an issue than is the false, deceptive and misleading reporting of the banks’ activities. It is in the national interest that this area be made right. Unfortunately as reported the meetings of the G20 heads and moved toward a less rigourous measure of assets. Banks ramaining houses of ‘spin’ will prolong the WFC which has its roots in banks having the inside knowledge that the other banks to which they would normally lend are as honest as they are.

Posted by Tony Dickensen | Report as abusive

Moody’s and other credit rating agencies rate the creditworthiness of banks and other financial corporations. Please start distributing the full text of Moody’s rating changes again. The Reuters newsfeed is signficantly more visible to readers than internet access and registration required Moody’s web site.

Posted by Tom | Report as abusive

You have big cooperative banks. Similar to CUs they don’t have to optimize profits for shareholders.

Posted by M | Report as abusive

I think the problem with Steve’s argument is that we have free markets and consumers have a choice, if they want to they can go to a smaller institutions they can. There are obviously larger gains from banking at a larger institution, they are less likely to fail than a ‘mom and pop’ bank.

This obviously outweighs the cost of dealing with what can often be a mind numbingly bureaucratic organization where the staff (at least in consumer banking in the UK) often reach lower levels of incompetence each day!!

Posted by Chris Allison | Report as abusive

No one seems to hit on the fact that the too-big-to-fail banks are actually entities that are too-big-to-be-managed. IMHO, if you start tracing backwards you will find that the inflection point was the repeal of the Glass-Steagall Act. Talk about not learning from the past. The super entities need to be downsized to their former glory because the current model of economies of scale and cross-selling remain the pipe dream they were when the financial lobby bribed the government to repeal the GSA.

Posted by AxW | Report as abusive

Personally, I like being a Bank of America customer. I keep extremely little cash in my checking account, instead using an online savings account for liquidity. But the nationwide access to ATMs and the convenience of knowing that no matter where I move there is likely to be a branch nearby is extremely important to me. Any proposal that breaks up big banks need to allow for the very real conveniences provided to consumers by extremely large national bank branches.

Posted by Mitch | Report as abusive

Do you know any credit unions in Greenwich Village? I can’t find any that aren’t employee only! I know it’s not much of a comment . . . but I thought it was worth a shot!

-Big Fan

Posted by James | Report as abusive

More people should consider credit unions as an option instead of the big banks. Two important facts that few people know: 1) You can become eligible to join several major credit unions via association memberships which are open to all. Two examples of major credit unions like this include Pentagon FCU and Alliant CU. 2) Regarding convenience, many credit unions are part of a Co-op network. You can take care of much of your banking business at branches of other credit unions which are part of the network.

Big banks are not the problem. Having big deposit banks taking risks in their “financial products” divisions is the problem. Putting “Glass-Stegall Act” back in effect would prevent this. Deposit banks should be the one of the most risk-adverse institutions period, along with insurance companies and pension funds. When you act like an investment bank or even own one on the same balance-sheet, you are opening yourself to a lot of risk and liabilities.

Wrong, America does torture !

Posted by Sam Alread | Report as abusive

Wrong. America does toture !

Posted by Sam Alread | Report as abusive

I am alittle shicked you are on the Board of a credit unionm, yet apparently know sl little about accessibility or availability.
Not only are there a number of very strong large national credit unions that anyone can join by being a member of an associatio (Pentagon, Alliant for example), but also many CU’s are members of a shared branching network. For example, I can access all branch services at moe than 1,000 credit unions by visiting a local member of the brach network. Try getting money out of a Chase account by going to a BOA branch !
Further, at least one national CU allows deposit items to be scanned in via you fax scanner without having to actually mail in the checks.

Posted by barry | Report as abusive
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