Illustration by Matt Dorfman
Small Banks, Big Banks, Giant Differences: Robert G. Wilmers
There are reasons for bankers like me to view these as good times. Bank profits are up and failures have ebbed. Nonetheless, I remain troubled about the state of the financial-services industry.
Here’s why: community banks have given way to big banks and excessive industry concentration; profits are increasingly driven by risky trading; leverage is taking precedence over prudent lending; compensation is out of control. This toxic combination leads to continued taxpayer risk and threatens long- term U.S. prosperity.
To understand the change, first consider history. Banking once was a community-based enterprise, relying on local knowledge to guide the process of gathering customer deposits and extending credit. Done well, this arrangement ensures that deposits are deployed into a diversified pool of investments, while providing depositors with liquidity and a return on their savings.
Over the past generation, however, the financial services industry changed dramatically. In 1990, the six largest financial institutions accounted for 9 percent of all U.S. domestic deposits. As of Dec. 31, 2010, the six biggest banks accounted for 36 percent of deposits.
Such concentration raises the concern that poor decisions at such outsized institutions can lead to systemic risk. But this risk is greatly magnified by the new way in which the major banks, those deemed too big to fail, are doing business today. The largest and most profitable bank holding companies have moved away from traditional lending and come to rely on speculative trading in all types of securities, derivatives, credit default swaps, mortgage-backed securities and other, even more complex and exotic financial instruments -- many of them associated with high leverage.
Engine of Income
Such trading now is the engine of income. In 2010, the six largest bank holding companies generated $56.1 billion in trading revenue, or 74 percent of their $75.7 billion in pretax income.
Trading revenue at these institutions distinguishes them from traditional commercial banks, which aren’t typically involved in such speculative endeavors. The Big Six institutions earned more than 93 percent of the trading revenue generated by all American banks during the past two years. To say these large institutions are the same species as traditional commercial banks is akin to describing dinosaurs as reptiles -- true but profoundly misleading.
To concentration and speculation one can add another dangerous element: outsized, bonus-based executive pay. This supersized compensation, like the trading itself, is something new under the sun for bankers -- and poses serious problems for the U.S. labor market and our most talented citizens.
Then Versus Now
Consider that in 1929 compensation for employees in the financial-services industry was just 1.5 times that of the average nonfarm U.S. worker. By 2009 employees in the securities and investments sector, which includes investment banks, securities brokerages and commodities dealers, earned 3.4 times as much as an average U.S. worker. The average 2009 investment banking compensation at four of the top banks was at least six times that of an average American worker -- while employees in the traditional commercial bank sector earned just 1.2 times the average nonfarm employee.
The chief executive officers at the top six bank holding companies were paid an average of $26 million in 2007, or 516 times the U.S. median household income. Indeed, those bank CEOs are paid 2.3 times the average total CEO compensation of the top Fortune 50 nonbank companies. This raises important questions: Should the CEOs of big financial services firms earn more than those in the general economy they are supposed to serve? Shouldn’t managers of companies that put capital to good use, and thus provide greater value for the overall economy by producing goods and services, be paid more than the bankers assisting them?
At Taxpayer Expense
All Americans have reason to be concerned about this disparity. The major Wall Street banks operate under the taxpayer-backed umbrella of the Federal Deposit Insurance Corp. and, as we saw in 2008, the Treasury Department and the Federal Reserve. To pay for the cost of such protection, legislators and regulators have forced thousands of Main Street banks like the one I run to absorb a larger, more expensive set of regulatory costs, including higher capital and liquidity requirements. This threatens to deny small-business owners, entrepreneurs and innovators the credit they need and on which the economy relies.
Such, I fear, are the bitter fruits of a financial services industry unmoored from its traditional role in the commercial economy and a regulatory regime that protects outsized compensation tied to trading. Regulators have failed to distinguish between trading activity and traditional banking, or to recognize that the activity of an institution, not its form, should be the proper focus of oversight.
New Rules Needed
Main Street banks are heavily regulated -- and have been for generations -- to ensure their safety, soundness and transparency. A new generation of regulation must now be applied to what has become a virtual casino. All the players must be included -- Wall Street banks, investment banks and hedge funds. Complex derivatives and credit default swaps must be brought out of the shadows and into public clearinghouses, so that markets can know their magnitude and extent.
Those financial institutions that engage in trading should live and die by the pursuit of their fortunes, rather than impose a burden on the whole economy.
It’s time to disentangle the trading of big financial institutions from their more traditional commercial banking operations and put an end to this unsafe business model.
(Robert G. Wilmers is chairman and chief executive officer of M&T Bank Corp. (MTB) The opinions expressed are his own.)
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