Straight Talk — End the TBTF advantage

The too-big-to-fail problem is often discussed as a matter of fairness but really, for community bankers, it is a matter of survival. Too-big-to-fail status is a tremendous competitive advantage.. Too-big-to-fail banks have a substantial cost-of-funds advantage over community banks. Because people understand that government will prevent large banks from failing, they are willing to accept lower interest rates on deposit accounts in exchange for safety. Everyone knows the government allows troubled community banks to fail, so those banks have to pay higher interest rates to attract deposits. Furthermore, the largest banks have access to wholesale funds through capital markets which prize government backing. Community banks, which rely on the Federal Home Loan Bank or correspondent banks for wholesale funding, have to pay higher rates to access that money.. A study published recently by the Washington, D.C.-based Center for Economic and Policy Research quantifies the cost-of-funds advantage of too-big-to-fail status. "The spread between the average cost of funds for smaller banks and the cost of funds for institutions with assets in excess of $100 billion averaged 0.29 percentage points in the period from the first quarter of 2000 through the fourth quarter of 2007, the last quarter before the collapse of Bear Stearns. In the period from the fourth quarter of 2008 through the second quarter of 2009, after the government bailouts had largely established TBTF as official policy, the gap had widened to an average of 0.78 percentage points," economists Dean Baker and Travis McArthur explain.. "Because of the government safety net being extended to investors who lend money to these banks, the TBTF banks are able to borrow at a much lower cost than banks who must borrow based on their own credit worthiness. The increase in the gap of 0.49 percentage points implies a government subsidy of $34.1 billion a year to the 18 bank holding companies with more than $100 billion in assets in the first quarter of 2009.". Too big to fail used to be a theoretical concept but now it is reality. If congress doesn't deal with it as the competitive threat that it is, the community bank presence in this country will suffer. Not only should financial reform legislation attempt to offset the systemic risk TBTF institutions pose, it should attempt to level the competitive playing field. In addition to paying fees designed to cover the cost of propping up TBTF banks when they get into trouble, these banks should pay fees that equal the value of the government subsidy they are getting.