Is “Too Big to Fail” Evolving Into “Too Small to Succeed”?

Posted September 20, 2017 by Michael M. Moran in From the Experts.

Coming out of the financial crisis so much attention, politically and economically, seemed to be focused on chants of “break up” the big banks. Irrespective of one’s view on the rationale of such a move — would global competitiveness potentially be exchanged for political expediency? Hadn’t some of the largest traditional commercial banks, such as JPMorgan Chase, effectively stepped up to deploy tremendous resources in helping resolve the haphazard ways of Great Recession poster kids like Lehman, Bear Stearns, Washington Mutual, etc.? Did some bailouts simply perpetuate the concept of moral hazard as few seemed to be truly held accountable during the chaos?

What is clear is that the concentration of banking assets continued to migrate to our nation’s largest institutions. As the chart below depicts, pre-crisis the five largest banks in the country controlled nearly $5 trillion, or approximately 46% of the industry’s total assets.

Fast forward to today, and the $9 trillion in footings at the nation’s five largest banks now account for more than 53% of the industry’s total assets. Side note, if you incorporate Goldman Sachs and its $900 billion balance sheet into the fold, since “technically” it obtained a banking charter during the financial crisis (while the aforementioned JPMorgan Chase did quite a bit of “clean up” work in growing to $2.6 trillion), they would rank #5 on this list and effectively push the concentration level to nearly 60% of the banking industry’s assets among the Top Six:

And, as the bottom-half of the above chart depicts, relative performance metrics (Return on Average Assets; Return on Average Tangible Common Equity) across the industry noticeably weaken as we gravitate toward our nation’s smaller community banks. Quite logically, even with fairly comparable (and healthy) capital support levels, relative price-to-tangible equity measures at the smaller banks reflect a noticeable discount when viewed against the averages reported in the larger asset classes.

There has been quite a bit of anecdotal evidence bantered about, particularly pertaining to the relative burden of regulatory costs shouldered by small community banks vis-á-vis their consolidated balance sheets (versus those costs being a bit more easily absorbed as larger banks build critical mass), but there may now be empirical evidence building to support these earlier concerns.

In a study prepared by the Federal Reserve Bank of St. Louis last summer ("Scale Matters: Community Banks and Compliance Costs"; Drew Dahl, Andrew Meyer, Michelle Clark Neely; Federal Reserve Bank of St. Louis, St. Louis, MO, July 2016), it was noted that "...the ratio of compliance costs to total noninterest expense increased substantially as the size of the bank decreased...for example, banks with assets of $1 billion to $10 billion reported total compliance costs averaging 2.9% of their noninterest expenses, while banks with less than $100 million in assets reported costs averaging 8.7% of their noninterest expenses."

In addition, the study commented that "...the differences in compliance cost expense ratios are qualitatively consistent with other estimates of relative regulatory burden." In looking at the data being compiled on this front, and the consistent theme emanating from the community banking sector to not punish our nation's smallest banks for the sins of its larger industry brethren, I remain cautiously optimistic that regulatory relief is coming.

As Federal Reserve Board Governor Jerome H. Powell noted in a speech: "The risks and vulnerabilities of community banks differ substantially from those of larger banks and an explicit tailoring of regulation and supervision for community banks is appropriate." ("Regulation and Supervision of Community Banks"; Jerome H. Powell; Annual Community Bankers Conference, Federal Reserve Bank of New York, New York, NY; May 14, 2015)

For our community banks, regulatory relief cannot come soon enough. But, we are still waiting.

In closing, attached please find our monthly summary of Michigan's financial institutions. As you and your Board take your organizations forward, please do not hesitate to reach out to me and/or my colleagues at ProBank Austin if we can be of any assistance in helping you assess the competitive landscape. Best wishes for continued success in 2017!

Michigan Banking Summary September 2017