Breaking up big banks

Abstract

This paper discusses the proposals to limit the size of the banks, also known as tackling the banks’ incentives to become “too big to fail”. I examine how regulations to curb bank size may affect banks’ operating costs. I analyze the relationship between the size of U.S. bank holding companies (BHCs) and their operating costs from 2001:Q2 to 2014:Q1. I find that rules to limit the size of banks could significantly reduce economies of scale. In particular, if large and cost-efficient banks become split into smaller parts, data processing, legal fees, audit and consulting expenses, expenses on premises are likely to increase.The second part of the paper deals with the phenomenon known as “too big to jail” and examines banks’ settlements. I compile a novel dataset on 341 litigation charges and settlements and find evidence that larger banks and banks with a higher credit risk, but not necessarily more systemically risky banks, face litigation charges more frequently. I do however observe that penalties had little effect on BHCs’ profitability, and that some of the largest banks continuously faced litigation charges which may imply that benefits from wrongdoing outweighed the costs or that many large banks relied on the fact they will be considered immune from prosecution due to their sheer size and their influence on the economy.