Point of View

Why Be Big?

At the end of 1990, there were 15,158 commercial banks and thrifts in the United States, according to the Federal Deposit Insurance Corp. By the end of last year, there were just 5,670. That, according to my calculation, is a 62.6 percent reduction in the number of banks over the last 27 years. Most of the decrease is attributable to the wave of acquisitions that have occurred throughout that period of time, as well as a significant number of failures during economic downturns in 1990-1991, and again in 2007-2009.

One consequence of this drastic reduction in the number of banks has been a corresponding increase in the number of very large banks, including eight that are over $250 billion in assets and of those, four that are well over $1.5 trillion. This development has had a significant impact on the evolution of bank regulation. The Dodd-Frank Act, which was enacted after the financial crisis, created separate regulatory requirements and supervisory regimes for Systemically Important Financial Institutions, or SIFIs, which until recently were banks over $50 billion in assets, and for Global Systemically Important Banks, or G-SIBs, which make the list based on their size and how deeply integrated they are in the global economy. There are eight G-SIBs in the U.S., including two investment banks, Goldman Sachs and Morgan Stanley. The recently-enacted bank deregulation bill did raise the SIFI threshold to $250 billion, although the Federal Reserve retains the authority under Dodd-Frank to impose those requirements on any bank below the new asset threshold if it deems that to be appropriate.

These large banks have been a subject of great discontent in certain political and regulatory circles because of the systemic risk they pose to the U.S. (and global) economy during a severe economic downturn. As far as I am aware, the industry’s consolidation (which really began in earnest in the mid-1980s) was not the result of an explicit government policy, although the regulators and policy makers in Washington of course knew what was occurring, and it seemed that they adopted a laissez-fair attitude to the industry’s downsizing. That is until the crisis, when it became apparent that the failure of one of these very large banks could punch a big enough hole to sink the U.S. economy.

So what is the advantage of being really big, as in the case of JPMorgan Chase & Co., which at $2.5 trillion in assets is the country’s largest bank by a country mile, particularly if systemic risk and tougher regulation are part of the bargain? Certainly, there is no advantage from a financial performance perspective. This issue, which contains Bank Director’s Bank Performance Scorecard-an annual ranking of the 300 largest publicly owned banks and thrifts-makes that abundantly clear. The results of this year’s ranking are consistent with past years-smaller banks make smaller profits, but are more profitable than much larger banks.

A persistent argument in favor of size in banking (as in other industries) has been economies of scale. But scale economies tend to diminish as banks grow in size, suggesting there is a sweet spot in the relationship between scale and performance. A 2016 study by two economists at the Federal Reserve Bank of Kansas City (titled “Has the Relationship Between Bank Size and Profitability Changed?”) found that bank profitability increases with size but at a decreasing rate as banks grow larger. It also found that business strategy and markets have just as big an impact on performance as size. One caveat about the Kansas City Fed study: It focused on small community banks and the scale advantages of growing from, say, $300 million in assets to $700 million. It didn’t address the scale issue in the context of vastly larger institutions. But it did make this conclusion: “While the smallest banks can benefit significantly from growth, the advantages of growth become progressively smaller until they are exhausted.” I would expect that if the authors are correct, the exhaustion of benefits is complete once you exceed $1 trillion in assets. Then the dynamic factor becomes diseconomies of scale.

Megabanks like JPMorgan play a vital role in our national economy. Small banks are an important engine in the economy as well because, collectively, they finance much of the activity of the nation’s small businesses. But it’s hard to imagine the world’s largest economy being powered by an industry comprised of just small banks, because in a big economy there are certain things that only big banks can do. It may seem ludicrous to compare the performance of a $5 billion asset bank to JPMorgan, which is why we divide the Bank Performance Scorecard into three separate asset categories. But our country’s biggest banks clearly need to perform better from a profitability standpoint to show that there is a real benefit to shareholders and policymakers in Washington from having grown so large.

One factor that could tip the scale economies in these banks’ favor is technology. The growth of a digital economy should allow the big banks to evolve some of their businesses to digital platforms that are much more efficient. We’re seeing that now in the retail deposit market, where big banks are mounting a huge challenge to smaller banks. But there’s much more work to be done.


Jack Milligan


Jack Milligan is editor-at-large of Bank Director magazine, a position to which he brings over 40 years of experience in financial journalism organizations. Mr. Milligan directs Bank Director’s editorial coverage and leads its director training efforts. He has a master’s degree in Journalism from The Ohio State University.

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