Size Anomalies in U.S. Bank Stock Returns and Banking Reforms

Abstract

Using unique data on over-the-counter bank stock prices and balance sheet information we explore bank funding cost differentials using the risk-adjusted return gap between the largest and the smallest depository institutions. We find that the largest commercial bank stocks, ranked by market value or gross deposits, have significant lower risk-adjusted annual returns than do small sized bank stocks even after controlling for standard risk factors including size. This return difference is one of the first instances of preferential treatment for large banks and can be attributed to the Banking Act of 1935 which authorized the FDIC to act as the liquidator for all insured banks, and to choose which bank would be resolved by purchase and assumption and which by liquidation. Failures of larger institutions tended to be resolved by purchase and assumption, which is preferred because it preserves the value of the going concern, while failures of smaller institutions tended to be resolved by payoff and liquidation. When examined during the period of 1926 to 1939, when there are no such guarantees, we do not find any risk-adjusted returns differences between different sizes of banks.