Earlier this month, the United States’ largest banks reported unprecedented growth that could spell trouble for the future of the financial system.
Collectively, the ten largest U.S. banks expanded by more than $1.2 trillion in the first quarter of 2020. JPMorgan alone grew by nearly 20 percent, becoming the United States’ first bank with $3 trillion in assets. The bank took in $273 billion in new deposits in just three months. That’s equivalent to JPMorgan acquiring PNC Bank — the country’s seventh largest depository institution.
This dramatic growth stems from two dynamics related to the coronavirus pandemic. First, as companies have drawn on their preexisting lines of credit and the Federal Reserve has flooded the markets with waves of liquidity, firms and investors have deposited massive sums of cash in their bank accounts. This influx of funds has been referred to as a “reverse run on the banks.”
Second, during periods of market stress – such as those we’ve experienced since March – deposits tend to flow into banks perceived as “too big to fail.” Customers move their money into the most systemically important banks because they believe the government would bail out such firms, if necessary.
The remarkable growth of the largest banks – seemingly overnight – is worrisome for three reasons.
First, many of these banks suffer from serious risk management deficiencies. According to the latest data from the Federal Reserve, almost half of the biggest U.S. banks are considered to be in unsatisfactory supervisory condition. That means these banks are ill-equipped to handle such a dramatic and sudden increase in size.
Second, even the best-managed banks could have difficulty safely overseeing billions of dollars in new deposits. Indeed, the last time a megabank experienced such drastic organic growth – when JPMorgan took in a flood of excess deposits during the 2008 financial crisis – it promptly lost $6 billion in the infamous London Whale trading scandal.
Finally, it is dubious that megabanks have sufficient capital cushions to maintain such massive balance sheets. Banks held barely enough capital to pass last year’s Federal Reserve stress tests based on economic projections far rosier than we are experiencing today. And, in fact, the banks’ financial statements released earlier this month reveal that their capital levels are already dropping — while the worst of the economic fallout is still to come.
From a public policy perspective, what is most inexplicable about the biggest banks’ organic growth is that they would not be permitted to achieve comparable expansion through mergers or acquisitions. Federal law prohibits banks with more than 10 percent of nationwide financial liabilities – i.e., JPMorgan and Bank of America – from acquiring another depository institution.
This restriction makes sense: The 2008 crisis demonstrated unequivocally that big banks can pose a threat to the financial system. Indeed, empirical studies confirm that a bank’s size is the primary driver of its systemic riskiness.
Why, then, can JPMorgan accept $273 billion of new deposits through organic growth, when it cannot take in any new deposits through merger? Either way, JPMorgan’s $3 trillion balance sheet poses equivalent risks to financial stability.
Policymakers have proposed a variety of ways to address the risks of “too big to fail” banks. Sen. Bernie SandersBernie SandersOvernight Health Care — Presented by March of Dimes — Abortion access for 65M women at stake Hospitals in underserved communities face huge cuts in reckless 'Build Back Better' plan Sanders urges Biden to delay Medicare premium hike linked to Alzheimer's drug MORE (I-Vt.), for example, has introduced a bill to cap bank balance sheets at approximately $600 billion. Sen. Elizabeth WarrenElizabeth WarrenWarren calls on big banks to follow Capital One in ditching overdraft fees Crypto firm top executives to testify before Congress Massachusetts Gov. Charlie Baker won't seek reelection MORE (D-Mass.), by contrast, would reinstate the Glass-Steagall Act and thereby force commercial banks to spin off their investment bank affiliates. These proposals deserve serious consideration.
At a minimum, however, policymakers should stop megabanks from growing any larger than they already are today. In light of their systemic importance, JPMorgan and Bank of America should not be permitted to expand any further — whether by merger or organic growth. The same restriction should apply to any other bank that exceeds the 10 percent nationwide liability threshold.
A rigid limit on bank size would be one of the most straightforward steps policymakers could take to preserve financial stability. Such a limit would not be unheard of — in fact, it would work similarly to the asset cap the Federal Reserve imposed on Wells Fargo in 2018 due to its repeated customer abuses.
Applying an asset cap to JPMorgan, Bank of America and any other bank that approaches 10 percent of nationwide liabilities makes sense for many reasons. For example, it would rationalize the inconsistency in federal law that irrationally favors organic bank growth over M&A. In addition, it would benefit community and regional banks, which face increasing competitive challenges because of the megabanks’ continued, unchecked expansion.
Most importantly, limiting the growth of the United States’ biggest financial institutions would shield consumers, the financial system and the broader economy from the all-too-familiar risks of dangerously large banks that we experienced in 2008.
Late last year, international regulators determined that JPMorgan is the most systemically important bank in the world, with Bank of America not far behind. At the current rate, these banks are going to come out of the coronavirus crisis with significantly larger systemic footprints. That would be an ominous sign for the future.
Jeremy Kress is an assistant professor of business law at the Ross School of Business at the University of Michigan. He was formerly an attorney in the Federal Reserve Board’s Legal Division.