WSJ Editorial Board Continues to Make Odd Claims About Bank Capital and Government Support

WSJ Editorial Board Continues to Make Odd Claims About Bank Capital and Government Support

Rarely does one read anything as wrong as this passage from a recent Wall Street Journal editorial (“Warren Democrats for Wall Street”) on pending Senate banking legislation: “Smaller banks are better capitalized than large institutions in large part because they don’t benefit from a government safety net.”

First, small banks benefit massively from a government safety net: on average, 64% of their liabilities are deposits insured by the FDIC (and therefore explicitly guaranteed by the US taxpayer), and 6% are loans from the Federal Home Loan Banks (GSEs with implicit taxpayer backing).  Those percentages are roughly double those for large banks (35% and 3.4%, respectively.  Large banks instead issue large amounts of debt in capital markets and accept more uninsured wholesale deposits – in other words, liabilities explicitly not guaranteed by the taxpayer.

Second, the major reason small banks hold more equity than large banks is because they are inherently riskier than large banks.  Their assets are less diversified geographically and by product line.  Certainly, a business model focused on home mortgages, construction, development and local small business lending has real benefits for the US economy, but it is much riskier than running a bank with geographical and operational diversification.

Consider also that the largest banks currently hold on average 28% of their assets in cash, cash equivalents or U.S. Treasuries while community banks hold only 7%.

One suspects that the editorial was seeking to suggest that the largest banks receive a TBTF subsidy when they issue long-term debt, but as noted in a recent TCH’s blog post and shown in recent studies such as the GAO report, Minton et al (2017), and Johnston (2016), there is no evidence of a TBTF subsidy for the largest banks using post-2010 data.  As of the end of last year, an index comprised of the largest banks long-term debt currently trades about 100 basis points wider than treasuries (risk-free) of the same maturity– not exactly the behavior of debt with a federal backstop. And of course smaller banks generally do not even issue long-term debt to the market because investors would disfavor such risky and illiquid debt, and the fixed cost of issuance would be high for those banks.  As noted above, they rely on the government safety net to issue their debt – the safety net from which the Journal inexplicably asserts they receive no benefit.

And they keep asserting it: an editorial on Friday, (“The Art of a Banking Compromise”) stated, again without explanation, that small banks “maintain much bigger capital cushions than the global giants since they don’t have a federal backstop.”

 

Disclaimer: The views expressed in this post are those of the author(s) and do not necessarily reflect the position of The Clearing House or its membership, and are not intended to be, and should not be construed as, legal advice of any kind.