Small Banks Are Good for Consumers

by: Felix Salmon

Kevin Drum has a few practical issues with my idea about capping bank size at $300 billion:

What happens when you have a whole bunch of banks all operating at their maximum allowed size? Do they keep taking in money but just sitting on it? Of course not. Do they essentially shut down, not taking any new customers? What about natural growth among existing depositors? (For that matter, what about natural asset growth?)

Even more important, what happens when banks can’t can’t compete with each other by growing? What would they compete on? My guess is that they’d they’d compete on keeping the biggest, most profitable customers and would pretty much lose interest in smaller customers. So small depositors would find themselves increasingly unwelcome, paying higher fees and penalties, having a harder time securing loans, and so forth. After all, what incentive would a capped bank have to treat small depositors decently if they don’t don’t really want them in the first place?

The first thing that a bank does when it starts bumping up against the cap is to start selling off its assets: that’s why I’m a fan of old-fashioned securitization, where banks genuinely move assets off their balance sheet. Kevin’s worried that securitization only applies to assets and not to liabilities, and he wonders what will happen to bank deposits; I’m less worried about that. But fine, if deposits grow too large, then maybe banks can be allowed to exceed the asset cap so long as they invest excess deposits only in Treasury bills. (Or, to put it another way, if you sell off a bunch of loans, you have to invest the proceeds in Treasuries if your deposit base is greater than the asset cap.)

There are other things banks can do to move excess deposits off their balance sheets: they can move big deposits into externally-managed money-market funds, for instance.

As for banks competing with each other by growing, I simply don’t believe that they do. That was the point of Mike’s post, at Rortybomb: when banks get big they’re less competitive, not more competitive. And I think that Kevin is just wrong when he thinks that big customers are more profitable than small customers. Check this out, on the subject of Mexico’s biggest microfinance lender, Compartamos:

Compartamos, which had 1.16 million clients and MXN5.73 billion in loans at the end of December, saw its net profit rise nearly 28% to MXN1.12 billion in 2008, giving the bank a return on average equity of 44%, compared with an average for Mexico’s banking sector of 12.5%.

Yes, that’s a 44% return on equity in 2008. There aren’t many banks which can say that.

If there was a cap on bank size, then small depositors would actually become more attractive to banks: you get a much higher return on assets when you’re charging a $25 fee to someone with $500 in the bank than you do when they have a lot more.

So I’m not worried about consumers being hurt by caps on bank size. Quite the opposite, in fact: I’m pretty sure they’d benefit. Just look at credit unions: they’re nearly always small, and they’re nearly always great for consumers. We should take that model and run with it.