The country’s biggest banks enjoy a financial advantage over their smaller counterparts thanks to the notion that they are too big to fail, according to a new series of research papers from the Federal Reserve.
The researchers, whose work does not represent an official position from the central bank itself, found that the five largest banks had a 0.31 percent advantage over smaller operations through 2009, which they say is statistically significant, even after the financial crisis. It suggests that this edge comes from lower funding and operating costs, which Wall Street critics say stems from the assumption that these banks will be deemed too big to fail in a crisis and would once again get bailed out. After Lehman Brothers’s bankruptcy, the biggest banks received taxpayer bailouts because lawmakers feared they would bring the whole financial system down. Federal Reserve Bank of Dallas President Richard Fisher told Reuters that the research shows “it is improper to ask the taxpayer to underwrite the non-commercial banking operations of a complex bank holding company.”
For their part, banking groups counter that it could be because larger institutions can offer more products and are better at diversifying risk.
The data the Fed researchers used doesn’t take the 2010 Dodd-Frank financial reform bill into account, which attempted to address the issue of too big to fail. But the four biggest banks have only grown larger since the financial crisis, holding $7.8 trillion in combined assets as of September, an increase from $6.4 trillion in 2008. And banks are failing one of Dodd-Frank’s key reforms aimed at ending too big to fail: their “living will” plans for how to resolve bankruptcies without endangering the system have fallen far short of the requirements. Meanwhile, Federal Reserve officials, including former Chair Ben Bernanke, have admitted in recent years that too big to fail hasn’t been fixed. Senators have similarly warned that the problem persists, from Elizabeth Warren (D-MA) to Chuck Grassley (R-IA).
This has prompted a chorus of voices calling to break the banks up. One Federal Reserve official proposed placing limits on bank size. A bipartisan duo of Senators, Sherrod Brown (D-OH) and David Vitter (R-LA), have called for breaking up the big banks, and the two introduced legislation that would require banks to hold more capital as a cushion around risky bets, which would force them to either raise money or shrink in size.