The Value of Large Banks, Simplified

30 Jul 2019
Read Time 5 mins
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Value of Large Financial Institutions

As July quickly turns into August and Congress adjourns for recess, many in Washington turn to their oft-delayed summer reading lists.  And while a book about the economic and social benefits of large businesses—including global financial institutions—may not scream “beach reading” to most, financial services policymakers would be well-served to add economist and George Mason University professor Tyler Cowen’s most recent publication to their lists.

Strong Banks, Strong Society

In his insightful new book, Big Business: A Love Letter to an American Anti-Hero, Cowen discusses the essential role of large businesses in a productive economy and addresses the disconnect between the public’s often skeptical view of such institutions and their value to society.  In a chapter specifically focused on the financial sector, Cowen takes a macro-historical view to observe that the rise of civilization—from the Greek city-states to the Renaissance—and the rise of finance have gone hand in hand.  Given this relationship, he succinctly concludes:

It is hard to imagine sustained economic growth without an ongoing and concomitant growth of banking and finance to allocate the capital that goes along with that new wealth.  Banking and finance take society’s saved resources and convert them into high-yielding investments, and without that function economic growth won’t take off.”

Viewing this relationship through a more U.S.-specific lens, Cowen continues:

Consistent with this truth, banking and finance are important for the building of the American republic, the settling of the nation, and the rise of New York as a major global city.  To side with banking and finance was to embrace these processes of development and to be on the right side of the debate.  The more radical Jeffersonians, who were skeptical of banking in quite general terms, also were skeptical about the broader industrialization of the United States.  Indeed, throughout the nineteenth century, anti-banking rhetoric was common in the United States and also quite similar to a lot of the current charge.”

Of course, the observation that banking industry growth is a predicate for economic growth more generally does not, in isolation, say anything about the composition of the banking system, meaning whether the system should be comprised of a larger number of smaller banks or a smaller number of larger banks.  To this point, however, the Forum has previously discussed economies of scale (the concept that larger institutions can scale up their production and benefit from production efficiencies, reducing costs with savings that ultimately can be passed along to customers) and recent research suggesting that increasing returns to scale is a consistent and robust feature of the banking industry.  What’s more, this research finds that these effects are largest among larger banks.

In addition to economies of scale, former Federal Reserve Board (FRB) Chairman Ben Bernanke identifies four key advantages of large banks: “greater diversification of risks, the spreading of fixed overhead costs over many activities, the ability to offer combinations of complementary products, and global reach.”  Cowen amplifies this point, noting that U.S. banks must have scale in order to compete on a global basis.

But, aren’t there risks?

While most policymakers generally acknowledge the fact that banking industry growth is necessary for any healthy economy, some have raised concerns regarding risks related to the size of large banks.  Contrary to the populist insistence that large banks should be broken up to mitigate these risks, Cowen again draws on historical experience to warn against the short-sightedness of such a proposal:

As the experience of the Great Depression shows, having a lot of very small banks is no guarantee against a terrible outcome and in fact may make an economy more vulnerable to systemic risk. If America were to break up its banks today, a big macroeconomic risk, such as a bursting bubble, would affect a larger number of smaller banks rather than a smaller number of large banks.  That wouldn’t necessarily be easier to handle, and in fact it could make crisis management more difficult by requiring the Fed to respond to a greater number of discrete points of danger.  That would mean more deals to be done, more bank CEOs to have to call on the phone, more mergers to encourage and oversee, more situations to monitor, and overall, probably, a greater rather than smaller number of headaches.”

Small banks have a great purpose in the American economy, serving communities in every corner of this country, and there is an important role in our ecosystem for financial institutions of all sizes.  But, this point—that smaller banks are no bulwark against systemic risk—is widely accepted by economists and other policymakers.  Former FRB Chairman Bernanke, for example, echoes this conclusion, stating: “Financial panics can occur in systems dominated by small banks as well as by large ones, as was the case in the United States in the Great Depression. (In contrast, Canada, which has only large banks, did relatively well in both the Depression and in the recent crisis). The basic elements of a financial panic—broad-based loss of confidence in banks, runs by providers of short-term funding, fire sales of bank loans and other assets, disruption of credit flows—can arise even without large banks.”  Rather than focusing on the size of the system’s banks, policymakers should instead consider the resiliency of the banking system to destabilizing shocks, as measured by capital, liquidity, risk management, and resolvability.  The Forum has discussed these issues at great length, and our recent letter to the global Financial Stability Board details the immense changes to the U.S. financial regulatory framework to strengthen the resiliency of Forum member institutions.

In addition to ignoring the possible increase in systemic risk that could result from breaking up large U.S. banks, calls for such an ill-conceived policy shift ignores two crucial facts.

First, contrary to a commonly repeated yet inaccurate assertion, the largest banks now represent a smaller percentage of total banking sector assets than before the financial crisis.  Specifically, Forum members comprised roughly 54% of total banking sector assets in 2018, compared to 62% in 2008.  Although banks of all sizes have grown steadily during the past decade, Forum member institutions have grown at a slower pace than other banks.  The trend is even more pronounced when considering the entire financial system, including nonbank financial institutions.  Here, Forum members comprised roughly 11% of total financial sector assets in 2018, compared to 14% in 2010.

Second, the U.S. banking sector is among the least concentrated of any major developed market in the world, as measured by the percentage of assets held by the three largest banks.  In countries such as the United Kingdom, Germany, France, Italy, Australia, Brazil, Canada, and Mexico, the three largest banks account for over 50% of total banking sector assets.  By comparison, the largest banks account for only 35% of total banking sector assets in the United States.  Each of the 5,000+ FDIC-insured commercial banks and savings institutions support the $20 trillion U.S. economy by serving consumers and businesses, both large and small.  The diverse range of banks helps to increase customer choice, allocate capital efficiently, and enable broad-based economic growth.


Many Americans are skeptical of large institutions, such as Congress, news organizations, organized labor, education and medical systems, and big business.  In a way, such skepticism is part of the American DNA dating back to the very beginning of the nation.  Yet, Cowen’s book is a useful and timely reminder that this view underappreciates the important contributions of big business—including large banks—to society, principally in the form of production and employment.  Of course, there will always be risks in the financial system; that will be true in any society.  Rather than taking the misguided and oversimplified view that downsizing our institutions can somehow eliminate risk, we should seek policy solutions that retain the many societal advantages offered by size and scale while also ensuring that our systems remain resilient and well positioned to serve the economy.

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