Large Banks Get 'Too Big to Fail' Subsidy in Crisis

GAO report finds the largest banks have more market advantage over smaller competitors in times of financial crisis than in economic boom times.

The largest U.S. banks enjoyed lower funding costs than smaller rivals during the 2008 economic crisis although that advantage has declined or reversed in recent years, according to testimony from a government watchdog.

A study by the Government Accountability Office (GAO), to be released in full later today, comes after two years of congressional and industry debate over whether large banks continue to get what has come to be known as a too-big-to-fail subsidy despite regulatory changes. Senators Sherrod Brown, a Democrat from Ohio, and David Vitter, a Louisiana Republican, requested the report in January 2013 and have scheduled a Senate Banking subcommittee hearing on it today.

The GAO study found that the largest banks receive more of a market advantage during financial turmoil than during economic boom times. However, the watchdog found that such advantages declined or reversed in 2013, according to testimony from Lawrance Evans, director of financial markets and community investment for the GAO.

“In times of crisis, the advantage is even bigger to the big banks, and that’s particularly alarming,” Brown said in a Bloomberg TV interview.

The report appears to provide support for both sides of the debate: Community bankers can claim they are still at a disadvantage. The largest financial institutions can highlight the decreased level of any advantage.

Voter anger soared over the use of hundreds of billions of taxpayer dollars to save large banks during the 2008 financial crisis. In response, Dodd-Frank gave regulators stronger authority to dismantle large troubled financial institutions. It also imposed higher capital and liquidity standards, as well as annual stress tests to assure they can withstand future crises.

A Treasury official who asked not to be named in advance of the report’s release said it shows that the advantage banks enjoyed during the crisis has largely been eliminated.

“These findings reflect increased market recognition of what we have consistently said: Dodd-Frank ended ‘too big to fail’ as a matter of law,” the official said in a statement.

According to Evans’ testimony, the GAO found that the largest banks had lower funding costs during the 2007-2009 financial crisis and those differences have since declined. The agency found “mixed evidence of such advantages in recent years.” Evans didn’t quantify the size of the subsidy.

In general, the GAO found that Dodd-Frank reforms, such as enhanced capital and liquidity standards, make the likelihood of a government bailout less likely while not completely eliminating it, Evans said.


‘Competitive Disadvantage’

“Regardless of the size of the subsidy, a subsidy is a subsidy, and it ebbs and flows but there is always subsidy,” said Camden Fine, president of the Independent Community Bankers of America. “Therefore, there is always a competitive disadvantage for community banks against mega-banks.”

Representatives of large banks have argued that any market advantages accruing from the notion that the government will rescue them in a crisis are insignificant. The Clearing House Association, which represents the largest commercial banks, released a report on July 28 that found “no evidence” that large banks enjoy any competitive advantages associated with market perceptions of implicit government support.

“We found that the funding differential has substantially subsided and some of the reports actually show there are no funding advantages,” Paul Saltzman, president of the Clearing House Association, said in an interview. “Regardless, those funding differentials are more than offset by the macro-prudential rules that are targeted to the large banks.”

Rob Nichols, president of the Financial Services Forum, a trade group representing CEOs of the largest financial firms, said any subsidy results mostly from investors’ preference for stability, diversity, and liquidity of the large banks.

“The GAO report confirms what we have seen in many recent studies: any cost-of-funding differential large banks once had has been dramatically reduced if not eliminated,” Nichols said in a statement. “Any very small difference remaining is consistent with cost-of-funding differentials seen in larger businesses across all sectors of the economy.”

Brown said the report reinforces his view that in times of crisis investors rely more on large banks.

“What matters is the investors, the market thinks 'too big to fail' still exists,” Brown said. “In times of economic crisis they are going to go in greater number to larger banks getting even bigger subsidies than they do now.”


Persistent Perception

Some lawmakers remain unconvinced that Dodd-Frank solved the-too-big-to-fail perception and have called for changes including higher capital requirements, decreasing the size of institutions, and new bankruptcy rules.

Brown and Vitter have proposed legislation to require banks with more than $500 billion in assets to hold capital of at least 15 percent of their assets, which is more than double the international Basel III standard.

Senators Elizabeth Warren, a Massachusetts Democrat, and John McCain, an Arizona Republican, have introduced a bill that would create a new version of the Glass-Steagall Act, the Depression-era measure that separated commercial and investment banking until its repeal in 1999. Neither the Brown nor Warren bills have seen movement in Congress.

The Dodd-Frank Act defines banks with at least $50 billion in assets as “systemically important,” subjecting them to additional rules and regulatory oversight. Regional banks have fought to increase that threshold to cover just the largest financial institutions.

The International Monetary Fund released a report in April that found that even after Dodd-Frank was adopted, the biggest U.S. banks saved $70 billion in funding costs because of their size. The New York Federal Reserve published a paper in March showing the five largest banks paid on average 0.31 percentage points less on A-rated debt than their smaller peers from 1985 to 2009. The report didn’t account for regulatory changes since the passage of Dodd-Frank.

It is unclear how much the debate over large banks’ advantages will subside with the GAO report. Brown is among those in line to be Banking Committee chairman if Democrats retain the Senate.

“Unfortunately this is an issue that can only be proved one way or another in the next crisis, and no one wants that to happen,” Saltzman said.

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