THREE CHEERS for the U.S. Federal Reserve for its recent study, “The Differential Impact of Bank Size on Systemic Risk, by Amy G. Lorenc and Jeffery Y. Zhang.
The study couldn’t come at a more critical time, as the Fed, Federal Deposit Insurance Corporation, and others immerse themselves in implementing the new requirements of the Crapo bank-regulation reform act.
“Our empirical results,” the authors write, “show that stress experienced by banks in the top 1 percent of the size distribution leads to a statistically significant and negative impact on the real economy. This impact increases with the size of the bank. The negative impact on quarterly real GDP growth caused by stress at banks in the top 0.15 percent of the size distribution is more than twice as large as the impact caused by stress at banks in the top 0.75 percent, and more than three times as large as the impact caused by stress at banks in the top 1 percent.
“These results,” they conclude, “support the idea that the largest banks should be subject to the most stringent requirements while smaller banks should be subject to successively less stringent requirements.”
Banking systems systems dominated by large banks are like a majestic ship — they can do many things; they move fast; they have big guns. But if one or two of these great vessels is hit, and sinks…
Community banks, by contrast, function like a network of rafts. They can’t move as swiftly. They don’t have huge guns. Water comes over the side and people get wet… but like a raft, the system doesn’t sink as readily.
Though the passage of the Crapo act in May was a valuable step, the fact remains, as we wrote at the time in “Fed, you’re up next, “it will take well beyond that for the Federal Reserve, FDIC, and other institutions to implement many of the new law’s provisions via regulation — and longer still for their impact to be felt in the real world.”
Note: the Fed acted in late August to implement an important increase in the threshhold level for small bank holding company policy statements to $3 billion — another step forward.
Here’s hoping the rule-writers at the Fed (att: Randal K. Quarles, pictured nearby) take the time to familiarize themselves with the Fed’s own important research contribution.