In the third paper in its Working Paper Series on the Value of Large Banks, The Clearing House examines existing academic literature on bank funding costs, noting the significant decline in large bank funding advantages post implementation of Dodd-Frank reforms.  The paper also explains how recent regulatory reforms affect market expectations and encourages policymakers to consider the net competitive effects of government policies on large banks.

Existing research does not demonstrate that large banks today enjoy significant unfair funding advantages due to market perceptions of implicit U.S. government support.

Newer research finds that any funding differences observed before or during the crisis have significantly diminished or no longer exist, and that any observed differences may be attributable to factors other than TBTF.  This includes two recent studies by Oliver Wyman, commissioned by The Clearing House, that examined deposit rates and bond spreads among banks of different sizes, and found no significant funding cost advantages attributable to TBTF perceptions.

Studies purporting to show consistent or increasing funding cost differences – mostly older research – suffer from critical design and methodological shortcomings, including examining the wrong data periods or overly broad data sets.

Recent regulatory reforms affect market perceptions that large banks enjoy implicit U.S. government support.

Financial regulatory reforms, including capital, liquidity, etc., are substantially enhancing the resiliency of both individual institutions and the banking system as a whole and are impacting market expectations regarding the possibility of default by a large institution.  Further, recent developments – including the “single-point-of-entry” resolution strategy for large institutions – are changing perceptions of the likelihood of government intervention in a future financial crisis.  As a result of these regulatory efforts, market participants are revising their expectations of government support accordingly.  

Policymakers should consider the net competitive impact of government policy, as many regulatory requirements tax the largest banks alone.

For any study of funding costs to be meaningful and provide a full and accurate analysis of competitive advantages among banks of different sizes, it must evaluate both the positive and negative effects experienced by these various sized banks due to government regulation and other mandates.  Large banks are increasingly subject to significantly higher regulatory costs.  Many of these regulatory costs uniquely impact the largest banks, a type of regulatory taxation.  Policymakers, regulators, academics, and others have observed that these costs “offset” any competitive advantages that may be attributed to government support.

For additional information, please contact Jill Hershey (Jill.Hershey@theclearinghouse.org, 202-649-4601), John Van Etten (John.VanEtten@theclearinghouse.org, 202-649-4617) or Kristin Richardson (Kristin.Richardson@theclearinghouse.org, 202-649-4616).