“Too Big to Fail” banks enjoy lower funding costs despite stronger regulations
Implicit subsidies for large systemic banks has come down since the crisis but it is still higher than before, reflecting an ongoing perception of government support for the largest banks.
While the US economic recovery has strengthened recently, the effects of the financial crisis and subsequent government intervention still linger. The problem of “too big to fail” banks continues to drive political debates, even as Dodd Frank regulations come into force.
The International Monetary Fund recently released estimates of the implicit subsidy for these TBTF banks in its biannual Global Financial Stability Report (GFSR). According to the report, the subsidies have declined but still remain high. In the US, the funding advantage came to at least 15 basis points, and the subsidy to just the largest systemic banks totaled between $15 and $70 billion. However, subsidies in the Euro area were as high as 60 to 90 basis points, reflecting the the slower pace of regulation and balance sheet repair.
There is still work to be done
The Federal Reserve’s top regulator, Daniel Tarullo, noted recently that “the financial architecture is considerably stronger today…but work remains to complete the post-crisis global reform program.”
Mark Carney, Governor of the Bank of England, expressed similar sentiment late last year: “Firms and markets are beginning to adjust to authorities determination to end too-big-to-fail. However, the problem is not yet solved.”
In the GFSR, the IMF highlighted how the banking sector in the US has become more concentrated since the crisis. Total bank assets as a ratio of US GDP were just below 90%, and the three largest banks accounted for roughly 45% of those total bank assets. Higher concentration increases the systemic risk presented by the failure of one institution. With a larger proportion of assets, the failure of one of these firms could still have an out-sized impact on the US financial system.
Recent research from the New York Federal Reserve indicates that the stronger government support perceived for systemically important banks does “translate into a higher ratio of impaired loans.” This further makes the case for continuing to work on too-big-to-fail. If these banks take advantage of perceived government support to take on higher risk, the threat presented by their greater concentration and size intensifies.
Size cap is not the solution
US politicians have advocated for more rigorous regulation and supervision for these banks. Senators Elizabeth Warren (D-MA) and Sherrod Brown (D-OH) have been particularly vocal on this issue.
Yet, capping bank size does not seem to be the best answer. In that same research from the NY Fed, researchers concluded that banks can enjoy economies of scale with consolidation. They found that restricting bank holding companies to 4% of GDP, as some have suggested, would increase total non-interest expense by $2 to $4 billion per quarter. The IMF seems to agree (albeit mildly), indicating market liquidity and efficient could decline “when banks’ activities are curtailed.”
This does not mean that regulations of TBTF banks will not increase. In the beginning of April, the Fed adopted an “enhanced supplementary leverage ratio” of an additional 2% for bank holding companies with more than $700 billion in consolidated assets.
Daniel Tarullo has hinted that the Fed and FDIC are mulling a rule requiring complex banks to “maintain a minimum amount of long term unsecured debt” to help with the resolution of these firms. For its part, the IMF wants to see more international coordination to identify the systemically important banks and agree on the capital surcharges necessary.
While this post crisis goal has remain unfulfilled, it looks like a safe bet that further regulation and supervision will be forthcoming for those firms judged to be “too big to fail.”