The Cost Consequences of Breaking up Large Banks: Do Large Banks Enjoy Technological Cost Advantages?

Joseph P Hughes

doi:10.4172/2168-9458.1000113

Abstract

Proposals to break up the largest banks seek to reduce the systemic risk they impose on the economy. However, if these banks experience scale economies that reduce the average cost of their financial products and services, breaking them into smaller institutions might reduce their ability to compete in global markets and provide them with incentives to evade break up and operate outside the regulated financial system - with the potential for new sources of systemic risk. Textbooks assert that large scale is associated with such cost economies, but the evidence for these economies is difficult to obtain. Is such evidence illusive or elusive? This paper explores some of the published evidence and the reasons why it is elusive, not illusive.

Highlights

The Policy DebateFisher [1], the president of the Federal Reserve Bank of Dallas, has asserted, “Hordes of Dodd-Frank regulators are not the solution; smaller, less complex banks are
Proposals to break up the largest banks seek to reduce the systemic risk they impose on the economy
Tarullo [4], a governor of the Federal Reserve System, has warned that there may be a trade-off between systemic risk and financial efficiency: “An additional concern would arise if some countries made the trade-off by limiting the size or configuration of their financial firms for systemic risk reasons at the cost of realizing genuine economies of scope or scale, while other countries did not

Summary

The Policy Debate

Fisher [1], the president of the Federal Reserve Bank of Dallas, has asserted, “Hordes of Dodd-Frank regulators are not the solution; smaller, less complex banks are. Tarullo [4], a governor of the Federal Reserve System, has warned that there may be a trade-off between systemic risk and financial efficiency: “An additional concern would arise if some countries made the trade-off by limiting the size or configuration of their financial firms for systemic risk reasons at the cost of realizing genuine economies of scope or scale, while other countries did not In this case, firms from the first group of countries might well be at a competitive disadvantage in the provision of certain cross-border activities.”. One of its investment strategies is to continue to operate with the same ratio of reserves and liquid assets to total deposits and the same ratio of equity to assets - point A’ represents the same expected return as the smaller bank but less risk due to better diversification. While smaller banks may pursue more conservative investment strategies to protect their charter made valuable by growth opportunities and market power, larger banks, operating in more competitive markets with less valuable growth

Smaller Output

Findings

Conclusions