Evan Soltas
Sep 25, 2015

What's the Case for Big Banks?

Ever since the global liberalization and deregulation of financial services began in the 1980s, banks have argued that it would be better if they were bigger.

Allow consolidation, bank executives have said, and customers can have what they want from their bank: a full suite of financial services from a bank with global reach and a deep knowledge of financial markets.

To be that kind of bank, however, takes scale. A smaller bank could take deposits and lend so people could buy cars and homes and so businesses could make payroll. But it would never be able to promise an individual a competitive interest rate or to help a business pay a supplier in Japan.

All that seems fair enough. There's a problem with the argument, though: It doesn't seem to be true in the data. If large banks had a competitive advantage, we would be able to see it in their return on assets. If return on assets doesn't increase with bank size, then it's hard to see why free markets would favor scale in banking.

To the banks' point, it does seem to be true that community banks -- those with assets under $1 billion -- operate at a severe disadvantage. The data suggest that, holding leverage constant, they could increase their value by roughly 20 to 30 percent from scale efficiencies. (This probably explains that the consolidation has been concentrated in these banks.)

Yet there's no evidence that returns to scale are increasing beyond that point. And community banks only control 14 percent of bank assets. So that's a free-market case against community banking, rather than one for the rise of the very largest banks.

This was something that researchers noticed in the early 1990s, back when bank consolidation was just beginning. It remains true. So, tell me, what's the free-market argument for big banks? In a world of "too-big-to-fail," the benefits that are supposed to offset the cost of implicit government subsidies are elusive.