For a large bank, how large is too large?
A series of sober economic studies over the last few years have looked at this question to try to identify the point where the economies of scale in banking give way to the diseconomies of scale. Together they suggest that banks start to run into trouble when they become larger than about $25 billion or $50 billion in assets. My own experience suggests that it is when banks get to about $120 billion in assets that the quality of the operation really starts to decline. Other studies point to problems with banks that have a large relative size, controlling roughly more than a third of the banking market in a country, region, or large city. The higher cost of operating the extra-large bank means it’s hard to compete with other banks. They’ll tend to look for ways to trick their customers into paying higher fees — the “gotcha” approach to banking is mainly a function of the bank’s size. Worse, at least from a regulatory standpoint, the extra-large banks invariably take more risks in an attempt to keep up with their more efficient competitors. As a result, they are more likely to fail.
Based on this, in the United States, banking customers ought to be cautious about doing business with the 39 largest bank holding companies. These are the banks that will try the hardest to trick you into paying fees you don’t want to pay. If you want to protect your bank accounts, Move Your Money has resources to support the move from the extra-large banks to community banks and credit unions.
They are also the banks that are most likely to fail as a result of taking risks with their assets. Economists and regulators have been discussing possible changes in regulations to deter the largest banks from the reckless behavior that comes naturally to a bank of that size. In the United States this is primarily a question for the Fed, which regulates bank holding companies, and the FDIC, which liquidates the largest bank holding companies when they fail.
There are also issues for credit rating agencies to consider. Credit ratings don’t take into account the greater risks that large banks take, and as a result, the largest banks have higher credit ratings than they deserve. Of course, if the largest banks were properly rated for their credit risk, that would increase their operating costs and put more pressure on them to take even more risks.
An Illinois bank failed tonight. State regulators closed The Bank of Commerce, with one location in Wood Dale, Illinois. It had $160 million in deposits. Advantage National Bank Group is assuming the deposits and purchasing the assets.