For Banks, Being Big Has Its Benefits

Critics calling for a breakup of the largest U.S. banks need to be reminded of the economies of scale and efficiency that come from being big.


Going back to its origins, the U.S. has had an uneasy relationship with bigness. The laws and body politic historically tilted toward dispersion of government and economic power. As different as today’s reality is from America’s agrarian roots, backlash against big government and big business has never been far from the surface.

Banking — high-profile and highly regulated — is a frequent flash point and may soon be again. A Democratic presidential contender, Senator Bernie Sanders of Vermont, wants to “break up these large financial institutions” that are deemed too big to fail. It’s not just populist rhetoric; that argument is also made in academic and policy circles by the likes of Richard Fisher, the recently retired president of the Federal Reserve Bank of Dallas; and Massachusetts Institute of Technology professor Simon Johnson, co-author of 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown. The sitting vice chair of the Federal Deposit Insurance Corp., Thomas Hoenig, has long advocated “a decentralized, less concentrated and less government-dependent banking system” and contends that on those counts matters are hardly improving.

Whether or not the pendulum may have swung too far, the U.S. banking industry and its oversight are inherently decentralized. Assets are less concentrated in the largest institutions than they are elsewhere in the world, and regulatory responsibilities remain divided among the 50 states and more than a few federal agencies. The mishmash didn’t seem to be a problem while the U.S. was growing into the world’s mightiest economic engine, a more dynamic and entrepreneurial marketplace than those countries with dominant, national champion banks.

Critics from Sanders to Hoenig articulate what might be called Dodd-Frank regret, or Glass-Steagall envy: Key objectives of the 2010 law remain unresolved or open to debate, in contrast to the 1933 reforms that unambiguously separated commercial and investment banking and reined in financial industry consolidation for the rest of the century.

As Hoenig stated in a May 2014 speech, “The largest financial firms today are in most instances larger, more complicated and more interconnected” than in 2008 — a fact that sends shivers through central bankers and regulators concerned about their ability to manage a major failure. The attention that needs to be paid to the systemically important banks (SIBs), their capital and leverage levels and the ever looming too-big-to-fail issue has become a global regulatory preoccupation and bolsters the antibigness case. Break up the problematic SIBs, and Hoenig’s call for less centralization, concentration and government-dependence is realized.

What is missing from that part of the conversation is an acknowledgment of the market forces and management logic that pushed these firms to get big in the first place. One motivation is that a bigger bank can better diversify its risks across geographies and sectors than can one with a locally concentrated portfolio. On the other hand, as Fisher has said, “because of their deep and wide connections to other banks and financial institutions, a few really big banks can send tidal waves of troubles through the financial system if they falter.”


But another dimension of bigness isn’t getting its due: economies of scale. According to aggregate data published by the FDIC, banks above $10 billion in assets are consistently at or near the top of the profitability chart in terms of return on assets and return on equity. And in cost-efficiency they are well ahead of the pack. The $10 billion-plus banks’ noninterest expense as a percentage of average assets — smaller numbers are better — was 2.55 in the first quarter of this year, 10 basis points under the industry aggregate and well below the 3.38 for banks with less than $100 million in assets. The biggest banks’ efficiency ratio (noninterest expense as a percentage of operating income) was 59.2, compared with 60.6 for all banks and 75.9 at those under $100 million.

Those are just crude measures of a big-bank advantage. Academic analyses in recent years have refuted earlier assumptions that economies of scale are lacking in banking, likely reflecting progress in automation and reengineering. Federal Reserve Bank of St. Louis research by economists David Wheelock and Paul Wilson has found “increasing returns to scale” and concluded that “the U.S. banking industry will continue to consolidate, and the average size of U.S. banks is likely to continue to grow unless impeded by regulatory intervention.”

Such intervention, though perhaps justified, would do well to take into account the benefits of efficiency.