The safety and soundness of the largest banks and the ability to resolve them without major systemic disruptions are key concerns emerging from the 2008 financial crisis. Authorities have responded by proposing and implementing substantial changes to the regulatory framework governing financial institutions. Despite these reforms, calls to break up the largest and most complex banks remain a part of the current policy debate. Yet, the significant benefits that large and complex banks offer to customers, businesses, and the economy are often absent in this post-crisis discussion. In this article, they examine the benefits that large banks provide to society.
They concur that these banks should be more resilient to financial shocks and that every bank should be allowed to fail in an orderly manner. There are two ways to achieve this objective. One alternative is to require increases in loss-bearing debt and equity capital, enhanced liquidity that can be available even under stressed financial conditions, and greater reliance on sources of stable funding. Calibrated correctly, these measures should encourage banks to adjust their scale and scope in ways that reduce their systemic risk contribution while maximizing returns for their shareholders. The second alternative is to impose “structural limits” on financial firms that address their size, scope, complexity, or interconnectedness in order to reduce systemic risk. In the United States, recent reforms rely predominantly on the first approach as being more likely to bring about desired prudential improvements while balancing systemic stability and economic efficiency. Recent reforms in the United States have gone a long way in addressing these issues and changing the perceptions that any bank is “too-big-to-fail” (TBTF).
In this context, one of the key building blocks in the decision process is a clear understanding of the economic benefits derived from large bank activities that are passed on to consumers, businesses, and the overall economy. Economists and policymakers have voiced their concerns about breaking up financial institutions without first conducting sufficient research on the benefits of large banks. Daniel Tarullo (2012), Federal Reserve Governor, stressed the need for further research on the structure of large banks, noting that “relatively little research has been undertaken” in regards to “scale and scope economies, especially as they relate to policy proposals directed at the too-big-to-fail problem in financial markets.” In addition, William Dudley (2012), President of the Federal Reserve Bank of New York, emphasized that “with respect to size limitations, it is important to recognize that a new and much reduced size threshold could sacrifice socially useful economies of scale and scope benefits.”
Literature examining the economic benefits of large banks focuses prominently on economies of scale. Recent studies suggest that economies of scale are present even at the largest banks. One academic study finds that breaking up the banks by imposing a $1 trillion size cap would cost society $79.1 billion annually (Wheelock and Wilson, 2012). An industry study estimates that the scale and scope benefits of large banks provide an estimated $50-$110 billion to society (The Clearing House (TCH), 2011). While additional research is warranted to fully quantify the value of large banks, these benefits would go a long way to offset the benefits of bank restructuring. Furthermore, there are various regulatory improvements that will continue to strengthen individual banking organizations and make the financial system more resilient to shocks.
In this article, they first explore the recent academic and industry literature on the benefits of large banks from the perspective of economies of scale and scope along with the benefits of a large, diverse set of products and services provided by a large bank. Second, we explore how large banks are able to leverage their broad customer bases to increase the pace and spread of innovations. Third, they discuss how risk diversification is a key benefit of large banks that augments their resiliency and stability. Finally, they examine the policy implications of our findings.
Their analysis finds the following:
- The most recent academic and industry research confirms significant scale and scope economies exist in even the largest banks.
- Scale and scope benefits are passed on to customers in the form of cost savings, technological advancements, increased convenience, and global reach.
- Given the continued progress in regulatory reform that increases financial stability and provides a more clearly articulated resolution process for any bank regardless of size, we find that the societal benefits of large banks should not be ignored when considering structural reforms.