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From Banking and Finance Law Daily, March 20, 2014

Brown, Vitter counter report finding insignificant difference in funding costs for megabanks

By J. Preston Carter, J.D., LL.M.

Senators Sherrod Brown (D-Ohio) and David Vitter (R-La) issued a press release disagreeing with the results of a study finding an insignificant difference in funding costs for the largest banks. The study was commissioned by The Clearing House Association and conducted by the management consulting firm, Oliver Wyman.

“It should come as no surprise that an industry-funded study stands in direct contradiction to what leading, independent economists, regulators, and other experts, say about the ‘Too Big to Fail’ subsidy enjoyed by megabank institutions,” Brown said. “This report only underscores the efforts by Wall Street megabanks to muddy the waters and protect the status-quo that requires hardworking taxpayers to pay for their risky activities.”

“When megabanks are already lobbying the GAO to protect their taxpayer-funded subsidies, it’s pretty obvious that they’d pay for studies that give them the results they want to see,” Vitter said. “But the facts are clear: too big to fail is alive and well, and we shouldn’t let megabank funded reports like these give them more ammunition to continue collecting from the taxpayers.”

Oliver Wyman Study. The purpose of the study—Do Deposit Rates Show Evidence of Too Big to Fail Effects?—was to contribute to the growing body of research regarding the measurement of so-called “Too Big to Fail” (TBTF) effects on the funding costs of financial institutions. The study measured differences in deposit funding costs by applying the methodology pioneered by Stefan Jacewitz and Jonathan Pogach in their 2103 working paper, “Deposit Rate Advantages at the Largest Banks,” to an expanded and updated version of the same source data.

The Clearing House stated that the study examined deposit rate differences among banks of different sizes and found that money market deposit rate advantages for the largest banks were just four basis points at the end of 2012. Further, the study found evidence that this small difference may not be attributable to TBTF perceptions—that is, potential perceptions among market participants that the government would intervene to prevent the failure of a large financial institution.

According to the study, its key findings include:

  • Deposit funding cost advantages for the largest banks amount to just 4 basis points over the 2010-2012 period. The results generally coincide with that of the earlier study in finding that large banks had a funding cost advantage of more than 30 basis points on uninsured money market deposit accounts prior to 2010. Using updated data, and after controlling for common balance sheet measures of risk, the study concluded that this advantage had shrunk dramatically by the end of 2012.

  • However, the study said, estimated funding cost differences between large and small banks likely incorporate effects unrelated to TBTF perceptions. First, the study found that large banks have a funding cost advantage on accounts that are explicitly insured. Therefore, they should not be affected by TBTF perceptions. Second, banks in the sample with total assets of $100 billion—$500 billion, none of which have been designated as Global Systemically Important Banks or are generally discussed as beneficiaries of TBTF beliefs, also accrue funding cost advantages relative to smaller peers in recent years.

“Using recent data is critical for any study that aims to inform the dialogue about TBTF because policymakers and regulators in the U.S. have made enormous changes to how we regulate large banks,” said Bob Chakravorti, Managing Director and Chief Economist at The Clearing House Association. “This study is important because it captures the impact of those changes on the funding costs of large banks.”

The Clearing House said that policymakers and regulators have taken important steps in recent years to address TBTF perceptions, including higher capital and liquidity standards and regular stress tests, intended to make large banks less likely to become financially distressed. Additionally, The Clearing House stated, the Dodd-Frank Act expressly prohibits taxpayer-funded bailouts and provides regulators with new tools to allow large banks to fail without triggering a crisis for the entire financial system.

Brown/Vitter proposal. Brown and Vitter countered the study’s finding by stating that experts have raised questions about the methodology behind past studies done by The Clearing House. They argued that the nation’s largest Wall Street banks enjoy an implicit guarantee—funded by taxpayers and awarded by virtue of their size—as the market knows that these institutions have been deemed TBTF.

According to the Senators, this implicit guarantee allows the nation’s largest megabanks to borrow at a lower rate than regional banks, community banks, and credit unions. They said this funding advantage, confirmed by three independent studies in the last year, is estimated to be as high as $83 billion per year.

Brown and Vitter renewed their call for passage of their bill, The Terminating Bailouts for Taxpayer Fairness Act (TBTF Act)—bipartisan legislation intended to ensure that financial institutions have adequate capital to protect against losses (See Banking and Finance Law Daily, April 24, 2013).

Their proposal would:

  • Set reasonable capital standards that would vary depending on the size and complexity of the institution. Economic and financial experts agree that adequate capital is critical to financial stability, reducing the likelihood that an institution will fail and lowering the costs to the rest of the financial system and the economy if it does.

  • Limit the government safety net to traditional banking operations. When the government established the Federal Reserve in 1913 as a lender of last resort and created deposit insurance in response to the Depression, most banks had enough shareholder equity equal to 15 to 20 percent of their assets. In the ensuing decades, the expanding federal safety net allowed financial institutions to depend less and less on their own capital. Federal support was stretched far beyond its original focus, particularly when financial institutions were permitted to enter into the business of insurance, securities dealing, and investment banking. Brown and Vitter’s bill would limit the government safety net to traditional banking operations, protecting commercial banks rather than risky, investment banking activities.

  • Provide regulatory relief for community banks. By reducing regulatory burdens on community banks, the Senators contend, they can better compete with mega institutions. Because community institutions do not have large compliance departments this legislation provides “commonsense measures to lessen the load on our local banks.”

The TBTF Act also would expand the definition of “rural” lenders that can offer balloon mortgages, create an independent bank examiner ombudsman that institutions can appeal to if they feel that they have been treated unfairly by their examiner, and adopt privacy notice simplification legislation.

Companies: Oliver Wyman; The Clearing House Association

MainStory: TopStory BankingOperations DoddFrankAct FinancialStability Privacy

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