Let Customers — Not Regulators — Decide the Right Size for Banks

To see why it's absurd for Washington to be debating how big the country's banks should be, imagine the following scenario:

You leave your hometown after high school to study and later work abroad for several years. After some time, you decide it's time to come home, at which point you reacquaint yourself with your high school prom date, who never left. You decide to get married. After the honeymoon, it's time to pay the bills, which means you have to choose how to bank. Your spouse has banked for years at a local small bank because of the personalized service it offers. It has only a few branches. But having moved around, you think fondly about all those times you found a bank branch during your travels — and you appreciate that you didn't have to close your account just because you moved to a different part of the state, let alone an entirely different state, or even abroad.

What's the right way to go? That's for you and your spouse to decide. The decision should not involve politicians and regulators.

Small banks may make more sense for people who seldom travel or relocate, or who use a limited range of services. Big banks may be preferable for people who move around more often or use a wider range of services — even with the advent of automated teller machines and telephone, online and now mobile banking. The best way forward is to let people vote with their feet, allowing banks to compete to offer the best service.

That this debate arises in the political realm reflects what has always been wrong with the U.S. approach to banking politics and regulations, ever since Thomas Jefferson — as an anti-Federalist defending agrarian interests — challenged Alexander Hamilton's Federalist vision of an urbanized America with bank-financed industrialization. Author Ron Chernow makes that point in his fabulous Hamilton biography. Two centuries on, the story hasn't changed much: "Jeffersonians" want lots of small banks, while "Hamiltonians" see nothing wrong with allowing some banks to get big.

Professors Charles Calomiris and Stephen Haber at Columbia and Stanford respectively, in their recent book "Fragile by Design," detail how populists and small banks in the United States historically colluded in the political sphere to prevent banks from getting too big. And now we have the Dodd-Frank Act, which through an evolving body of regulations seems intended to encourage shrinkage, though it may also — as an unintended consequence — work to the detriment of small banks (as my colleagues Hester Peirce, Ian Robinson and Thomas Stratmann have shown with research on how small banks are faring under Dodd-Frank).

To be fair to the politicians and regulators involved in designing and implementing Dodd Frank, the issue of bank size ties in closely to the complexity of a bank's activities, because some complex activities — like structuring collateralized debt obligations — lay at the heart of the recent crisis. Since the repeal of Glass Steagall through the Gramm Leach Bliley Act in 1999, some big commercial banks have greatly increased their use of complex off (bank) balance sheet activities to engage in transactions that were previously the sole province of investment banks.

Interest in such activities reflects the fact that as accounting rules, banking regulations and tax laws become more complicated, so have the ways of getting around the rules. But complexity and bank size are two separate issues. This is why some regional banks, like PNC, can credibly challenge the "systemically important financial institution" or "SIFI" designation, on the grounds that they were not involved in the recent crisis.

To address complexity, how about simplifying banking regulations by simply raising capital requirements even more, as many advocate in various forms? Likewise, to address size, how about letting customers decide how big their banks should be?

Many U.S. politicians, regulators, populists and small bankers want to convince us we should fear big banks. After four years, it seems the bigger concern lies with the regulatory burden made worse by Dodd Frank. That's because — to the extent that it greatly increases the cost of banking — those costs will be passed on to the customers in the form of fewer services, fewer branches, higher fees, and overall, even more customer dissatisfaction.

Stephen Matteo Miller is a financial markets scholar and member of the Financial Markets Working Group with the Mercatus Center at George Mason University.