Only Congress thinks Main Street banks are 'too big to fail'

Article Highlights

  • No one is shedding tears over banks being designated systemically important under Dodd-Frank, but they should.

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  • Dodd-Frank Act lumps together regional banks with banking behemoths and treats them basically like equals.

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  • Allow banks to opt-out of their SIFI designation based on size and instead be reviewed based on systemic risk factors.

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No one is shedding tears over banks being designated systemically important under Dodd-Frank, but they should. Most designees had nothing to do with the financial crisis and don't pose a threat to economic stability, but they're subject to the full brunt of Dodd-Frank's rules.

The result? There's less competition and supervision for banks widely regarded as "too big to fail" – the exact opposite of what policymakers intended. Fortunately, there's a simple fix: change how banks are designated.

For nonbanks, such as AIG and GE Capital, there is an extensive list of criteria for receiving the Dodd-Frank-created systemically important financial institution designation, such as interconnectedness, liquidity and existing regulatory scrutiny. For banks, there's only one: size. If a bank has over $50 billion in assets, it's automatically a SIFI.

SIFI is not synonymous with Wall Street. While the six big-name Wall Street banks are included, the other twenty-seven SIFIs are Main Street banks, like M&T Bank out of Buffalo, KeyCorp out of Cleveland and Regions Financial out of Birmingham. These banks bear none of the traditional markings of being "too big to fail". They operate regionally with limited interconnectedness. They generally don't have complicated business strategies or trading operations. They receive little-to-none of the supposed $83 billion subsidy that accrues to "too big to fail" banks according to an oft-cited study. Even from a size perspective, they're relatively small. Their assets combined are half the size of the big six.

To be sure, it would be terrible if any of these regional banks failed. But no one thinks PNC or Zions Bank pose an existential danger to the U.S. economy.  After disposing of hundreds of bad banks during the financial crisis, the Federal Deposit Insurance Corp. could handle their failure in a weekend.

Dodd-Frank turns a blind eye to these differences. It lumps together regional banks with banking behemoths and treats them basically like equals. SIFIs of all sizes must comply with the biggest guns Dodd-Frank has to brandish, Sections 165 and 166, which prescribe extensive capital, liquidity, exposure requirements and more. They must undergo public stress testing and create living wills – an extensive planning process showing regulators how to wind down firms in a time of crisis. And while smaller banks have carve-outs from complying with the 398 rules resulting from Dodd-Frank, SIFIs have none.

SIFI compliance costs a lot of money, which disproportionately impacts the "small SIFIs." Just filling out paperwork for the Dodd-Frank rules proposed or passed so far will take 58.3 million hours or 29,192 full-time employees industrywide. Standard & Poor's estimates that Dodd-Frank compliance will cost the biggest eight banks alone up to $34 billion.  Big banks like JPMorgan Chase or Bank of America have teams of people (and budgets) to handle such compliance; small SIFIs don't. Several of them also don't have full-time Washington lobbyists on staff.

Not surprisingly, there aren't many banks jumping up and down to enter the SIFI club. In fact, there are now about ten U.S. banks hanging just below the $50 billion threshold. The high cost of dealing with the attendant rules will dissuade these firms from growing bigger. Translation: current SIFIs are safe from competition. In this way, the SIFI designation protects big banks, hardly what the authors of Dodd-Frank intended. Banks that are really good at serving businesses and individuals should be allowed to grow free of an artificial, government-imposed cap.

For those banks already designated, SIFI rules are a wet blanket on business. This is bad news for the economy. The SIFIs are responsible for the vast majority of credit. Unduly paralyzing these institutions with new rules will slow economic growth and keep credit tighter for longer. Given that the majority of SIFIs did nothing to warrant the additional scrutiny, they should be encouraged to innovate and serve customers, instead of spending their resources on Washington.

The broad SIFI designation brings yet another complication – it distracts regulators from firms that actually pose a systemic risk.Dodd-Frank put in place an expansive new regulatory structure to oversee systemic risk, including an entirely new regulatory body, the Financial Stability Oversight Council.  But, instead of concentrating their efforts on understanding firms commonly thought of as "too big to fail," FSOC is required by law to supervise regionals.  Even regulators privately admit the threshold is a distraction.

If Congress is serious about protecting us from the next financial crisis, I propose they repeal the arbitrary $50 billion cutoff for banks and instead use similar criteria to that for nonbanks banks to determine which are systemically important. Criteria good enough to determine if AIG is systemic should be good enough to determine if Comerica Bank is.

Removing the arbitrary size designation would reduce costly regulation for firms that had nothing to do with the crisis. It would allow banks to compete without artificial size restraints, draining the "moat around JPMorgan Chase" CEO Jamie Dimon famously claimed Dodd-Frank created. And it would allow regulators to concentrate their efforts on firms that actually warrant their attention as systemically important.

As for those who claim banks like the SIFI designation because it gives some sort of implicit benefit, this would be the perfect test: Allow banks to opt-out of their SIFI designation based on size and instead be reviewed based on systemic risk factors. Let's see how many opt-out and how many get re-designated.

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About the Author


  • Abby M. McCloskey is the program director of economic policy at the American Enterprise Institute (AEI) where she disseminates the work of AEI’s economic policy team. McCloskey also studies and writes about various financial services policy issues.

    Immediately before joining AEI, McCloskey was director of research at the Financial Services Roundtable where she worked on financial regulatory reform, including Dodd-Frank and Basel III. McCloskey has also worked for US Senator Richard Shelby, and for the Mercatus Center as a Charles Koch Institute associate. While at Mercatus, she created and hosted a video series on financial markets issues.

    McCloskey has a B.A. in economics from Wheaton College.

    Follow McCloskey on Twitter: @abbyeconomics

  • Phone: 202.862.5819

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