Why Big Banks May Be at an Annual $14 Billion Disadvantage

The Government Accountability Office soon will release its study assessing the subsidy of the biggest U.S. banks. Let’s hope it does a better job than Bloomberg.

Earlier this year, Bloomberg editors reported the ten biggest U.S. banks receive an $83 billion taxpayer “subsidy” a year. The subsidy doesn’t mean taxpayers pay a lump sum to big banks. It means that big banks can borrow at lower rates than small banks because it’s believed they will be bailed out instead of failing in an emergency.

The $83 billion statistic has been widely cited in congressional testimony and op-eds by industry experts such as Richard Fisher, president of the Dallas Federal Reserve; Camden Fine, president of the Independent Community Bankers of America; and Sen. Elizabeth Warren, D-Mass.

Sens. Sherrod Brown, D-Ohio, and David Vitter, R-La., introduced legislation to eliminate government subsidies enjoyed by trillion-dollar megabanks, citing the $83 billion advantage.

Unfortunately, repeating a statistic doesn’t make it true. In reality, the biggest banks in the U.S. are probably operating close to a $14 billion disadvantage annually. The difference can be explained by a slip of the pen by Bloomberg and the cost of 398 new rules from the Dodd-Frank Act. 

Bloomberg’s estimate was based on a 2012 IMF Working Paper by Kenichi Ueda and Beatrice Weder di Mauro. Ueda and di Mauro use the government support rating from Fitch to assess the funding advantage of banks worldwide, many of which benefit from more explicit government support than in the U.S. They find banks were able to access funds for 80 basis points cheaper in 2009. Bloomberg multiplied 80 basis points by all the liabilities of the ten largest U.S. banks, which led to the $83 billion estimate.

The $83 billion estimate may or may not accurately describe banks’ funding conditions during the worst economic collapse since the Great Depression. But it certainly is not the annual funding advantage of large banks, as implied by Bloomberg.

Historically, there are huge differences in bank funding levels during economic crises and normal times. Moody’s estimates the largest 20 U.S. banks had a 23 basis point funding advantage over smaller institutions pre-crisis. The official IMF estimate of the big bank funding advantage worldwide is 20 basis points as of 2010.

During 2007 to 2009, the funding advantage grew for banks in nearly all developed countries. The IMF reports that the largest 10 banks in each G20 country had, on average, a 65 basis point funding advantage during the peak of the crisis. The Center for Economic Policy Research estimates that the difference in the cost of funds between large and small U.S. banks reached 78 basis points by mid-2009. (CEPR researchers note a similar increase occurred at the end of the recession in 2001, suggesting that economic uncertainty alone may account for part of the funding advantage as few, if any, large banks were are risk of failure that year).

After the crisis ended, the funding advantage began to shrink. Anthony Haldane, executive director of financial stability at the Bank of England, estimates that the funding advantage for U.K. and global banks more than halved from 2009 to 2010 alone. Moody’s and Standard & Poor’s lowered their projections of government support for U.S. banks, following the passage of the Dodd-Frank Act, which made it easier for banks to fail and imposed hundreds of new rules on the banking sector.

For the sake of argument, let’s assume the big bank funding advantage returns to its historic average. Following Bloomberg’s approach, multiplying 20 basis points – the official IMF estimates post-crisis – by the liabilities of the ten largest U.S. banks generates a subsidy estimate of roughly $20 billion. This is still a considerable amount, but a fraction of the crisis-level estimate.

But wait. Standard & Poor’s estimates the largest U.S. banks are expected to shoulder an extra $34 billion each year in compliance costs to satisfy new Dodd-Frank rules. Accounting for these new costs, the $20 billion funding advantage becomes a $14 billion annual disadvantage.

It’s hard to feel bad for big banks losing money. However, it is important to balance the funding cost advantages of large banks against the government-imposeddisadvantages when deciding policy adjustments to “level the playing field” so banks of all sizes can compete freely.

Additionally, there remains this nagging question about where the funding advantage actually comes from. Most academic literature concludes it is very difficult to isolate if large financial institutions have lower cost of funds from competitive advantages, such as more liquidity, diversification, government support or something else. Across all industries – not just banking – the largest companies tend to have a lower cost of funds than their smaller counterparts. It would be a mistake to frame policies that intentionally impose additional costs on large banks that offset market-derived competitive advantages.

Hopefully, the GAO report brings more clarity to the size, fluctuation and source of the subsidy. As of now, there are plenty of reasons to reform the U.S. banking industry. An $83 billion subsidy estimate should not be one of them.

Abby McCloskey is program director of Economic Policy at the American Enterprise Institute. She was a staffer for Senator Richard Shelby during financial reform and director of research at the Financial Services Roundtable.