Is Big Really Beautiful?

Bill Dunkelberg is currently a professor of economics at Temple University where he served as dean of the School of Business from 1987-95. Prior appointments were at Purdue, Stanford and the University of Michigan. He has served as the Chief Economist for the National Federation of Independent Business for 35 years, is the Chairman of Liberty Bell Bank (NJ) and Economic Strategist for Boenning & Scattergood (1914, Philadelphia).

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In a recent Financial Times editorial (July 30), Josef Ackermann of Deutsche Bank made his case for larger banks, arguing that they are beneficial and only the “interconnectedness” of banks caused our massive financial market failure. “Big , beautiful banks” may have nice, expensive buildings (if you happen to be in one) but little else to recommend them. Small banks may not have ornate, expensive buildings, but they get the job done with far less risk and cost to consumers and shareholders. Research undertaken by the Board of Governors of the Federal Reserve found few if any benefits to scale beyond $5 or $10 billion in asset size. So, for customers and shareholders, big is not obviously better, although for executives, life is good, pay is great.

The ultimate in “interconnectedness” is one bank with thousands of branches. So with one bad decision at headquarters, the entire system goes down. Credit standards are set by one officer for the entire economy, there is no “competition” for innovation in lending technologies or risk-taking. Mr. Ackermann is correct about the risk of interconnectedness as was illustrated by news headlines last fall: “Credit markets frozen – banks wont led to each other.” I thought banks were supposed to lend to consumers and businesses, not to each other. That was indeed the start of our troubles.

In a globalized market, “trapped pools of liquidity and capital” would not occur, capital flows easily where returns call. But with many independent suppliers of capital, there is more scrutiny, less chance that one big pool of capital will be poorly allocated or put at risk by risk-taking adventures or bad decision making.

Studies of the National Federation of Independent Business’ (U.S.) hundreds of thousands of members revealed that SMEs were best served in the U.S. in unit banking states (banks were allowed only one branch) and least well served in states allowing state-wide branching. Loan terms and satisfaction were always highest in states permitting only one bank branch. Big banks do not serve this vital economic community well. The 8,000 independent banks in the U.S. buffered the financial shock for SME’s, and now are unfortunately being required to pay for the losses to depositors generated by “large” banks. FDIC insurance costs are typically 500% higher than just two years ago, seriously impairing the earnings of these smaller banks.

Maybe we wouldn’t need “internationally coordinated crisis management” if we didn’t have mega banks lending to each other into markets that they are unfamiliar with, taking risks they should not take with our money. Large banks may be useful for large firms, but they need not be nearly as large as those we have today or that we had last year before they brought down our financial system.