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Study Fuels Fight Over Edge For ‘Too Big To Fail’ Banks
From Law 360
By Evan Weinberger
March 19, 2014
New York — A top banking industry group on Wednesday released a study it says debunked recent criticism that banks perceived to be “too big to fail” enjoyed access to cheaper funding than their smaller rivals, but advocates of shrinking the biggest banks said the report’s methodology lacked credibility.
The question of whether the country’s largest financial institutions have lower funding costs because of a belief that the government will not let them fail has become a part of the broader heated debate over whether some banks remain too large. Critics say that there is a subsidy, and that is proof that the market believes the government will continue to step in a crisis.
The study commissioned by The Clearing House Association found that rather than enjoying a steep subsidy because of the belief that the government would bail them out in a crisis, the largest U.S. banks saw a miniscule 4 basis point advantage in their money market deposit rate over smaller institutions.
The Clearing House-sponsored study also said that the perception that banks are too big to fail has played little to no role in that lower funding, in part because of regulatory changes brought about by the Dodd-Frank Act that both make bailouts illegal and aim to make banks safer, sounder and easier to take apart despite the perception that the government would step in a crisis.
“We believe, however, that it is more plausible that the widespread policy efforts to change those perceptions has had an effect on them, in addition to reducing the perceived probability of distress,” the report, compiled by researchers at consulting firm Oliver Wyman, said.
The Oliver Wyman researchers essentially followed a methodology developed by a pair of independent economists, Stefan Jacewitz and Jonathan Pogach, in a 2013 study looking at the deposit rate advantage large banks had over small banks.
The 2013 study found that the largest banks did have a significant deposit rate advantage over their smaller competitors between 2006 and 2008, meaning that they could pay out lower interest rates to depositors. Much of that advantage was tied to the government’s extraordinary efforts to buttress the banks using bank bailouts.
As the crisis abated and the financial system strengthened, the difference in deposit rates at the largest banks and their smallest competitors shrank, the Jacewitz and Pogach study said.
But the 2013 study only followed deposit rates through 2010.
Wednesday’s report largely uses the same methodology as Jacewitz and Pogach, but extends through 2012. It shows that the differences between what the too-big-to-fail banks and smaller institutions pay on federally insured deposits had narrowed to a negligible 4 basis points.
“Using recent data is critical for any study that aims to inform the dialogue about [too big to fail] because policymakers and regulators in the U.S. have made enormous changes to how we regulate large banks,” said The Clearing House chief economist Bob Chakravorti in a statement.
Using data through 2012 allowed the Oliver Wyman researchers to capture the effects of higher capital requirements, living wills for large banks and the Federal Deposit Insurance Corp.’s still-developing power to unwind a large, global financial institution and other regulatory changes to banks’ operations, he said.
The issue of whether too-big-to-fail banks have a distinct subsidy, and lower borrowing costs, because of the perception that they will be bailed out is more than an academic one, however.
Critics of the big banks have been using the argument that the largest banks have a funding advantage as a major plank in their push to shrink those institutions.
Not surprisingly, those critics dismissed The Clearing House-commissioned report.
“This report only underscores the efforts by Wall Street megabanks to muddy the waters and protect the status-quo that requires hardworking taxpayers to pay for their risky activities,” Sen. Sherrod Brown, D-Ohio, said in a statement.
Brown and Sen. David Vitter, R-La., introduced the Terminating Bailouts for Taxpayer Fairness Act last year. That bill would require the largest bank holding companies to maintain even higher capital levels than those required under the Basel III international banking accords and the Dodd-Frank Act.
The two senators also commissioned the U.S. Government Accountability Office to perform its own study on the size of subsidies the largest banks have.
In November, the GAO found that the largest banks benefited most from the government’s extraordinary measures to support the banking system during the financial crisis.
In part, that was due to the biggest banks’ funding needs. Many of their smaller competitors are funded by deposits, while the larger, more diversified financial institutions relied more on market mechanisms for necessary funding at a time when the market had all but frozen, the GAO said.
The GAO is set to release a report later this year that will attempt to put a number on the size of the subsidy big banks receive, if there is one.
That report has huge implications for the debate on whether the era of too big to fail has ended, and Wall Street has moved to influence it.
When megabanks are already lobbying the GAO to protect their taxpayer-funded subsidies, it’s pretty obvious that they’d pay for studies that give them the results they want to see,” Vitter said in a statement.
Other critics of the Clearing House-commissioned report have pointed to problems with the methodology.
The study “conflates deposit funding with overall funding. This sets the study off on shaky ground,” said Cornelius Hurley, the director of Boston University‘s Center for Finance, Law & Policy.
What the study does not take into account is other types of creditors that would be willing to give the biggest banks a break because of a perception that they will be bailed out by the government in a crisis, said Bartlett Naylor, Public Citizen’s financial policy advocate.
“They’ve chosen to dissect and focus on insured deposit costs, which to me is somewhat beside the point. It’s the debt creditors who presumably will lower their rates to a too-big-to-fail bank compared to a small bank in Idaho,” he said.
But the study found that although the biggest banks rely less on deposits than their smaller counterparts, deposits still make up their largest single source of funding, a fact common throughout the banking industry.
Using the largest source of funding allows for a useful comparison, especially since smaller banks rely less on repo markets and other funding sources than the largest institutions, the study’s authors said.
Given the skepticism that greeted The Clearing House study, clarity on the level of too-big-to-fail subsidies is likely not going to be reached until the GAO weighs in later this year.
However, that study is unlikely to end the fight over whether Dodd-Frank and other financial regulatory reforms have truly ended the era of bank bailouts.
Read more: law360.com