Big Banks’ ‘Too-Big-to-Fail Subsidy’ Is Waning, GAO Finds

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

A study by the Government Accountability Office, released 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.

The GAO study found that the largest banks receive more of a market advantage during the 2008 financial turmoil than during economic boom times. However, the watchdog found that such advantages declined or reversed in 2013, according the report.

“Unless you think we can eliminate financial crises forever, the GAO’s report is another reminder that we have more work to do to eliminate too-big-to-fail policies, and the advantages and distortions that they create,” Brown said at the a hearing on the report by his Senate Banking subcommittee.

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.

Ending Bailouts

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.

Mary Miller, Treasury Department undersecretary for domestic finance, said in a letter responding to the report that it shows that the advantage banks enjoyed during the crisis has largely been eliminated.

“We believe these results reflect increased market recognition of what should now be evident -- Dodd-Frank ended ‘too big to fail’ as a matter of law,” Miller wrote.

The GAO report found that the 2010 Dodd-Frank law could make the possibility of a bailout less likely. The GAO said that any perceived market subsidy may reflect investors’ beliefs of a bailout and characteristics of a bank. The watchdog cautioned that these estimates are not indicative of future trends.

Diminished Risk

In general, the GAO found that Dodd-Frank reforms, such as enhanced capital and liquidity standards, reduce without eliminating the likelihood of a government bailout. The GAO also concluded that the regulatory changes could increase costs to the largest banks relative to smaller competitors. The report used 42 models to study market perception of banks with assets of more than $500 billion from 2006 through 2013.

“During a crisis, there is a natural flight to safety. In crises, market participants generally consider larger, more diversified firms to be safer,” said Tony Fratto, managing partner at Hamilton Place Strategies LLC, a Washington-based consulting firm for financial companies. “A funding advantage should be expected for this reason alone and shouldn’t surprise anyone.”

‘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.”

Investors’ Preferences

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.

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.

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.

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