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Too Big or Too Expensive To Fail?

It is talked about everywhere. From the HBO film Too Big To Fail, to a recent article in the New York Times. Will we ever see one of the big four US banks fail? The smallest of the big 4 is Wells Fargo, and they have over three and a half times the assets of the fifth largest bank, US Bank. The trends in bank shut downs by the FDIC seem to indicate that they are more concerned by the smaller banks with capital issues than the larger ones. In addition, can our economy really handle a mega bank failure?

Soon IDC Financial Insights will be publishing our annual state of the banking industry report. In this report, we track the failures over the last few years as well as some developing industry wide trends. What is compelling is that in 2011 there was not one bank failure of an institution greater than $10 billion. From a pure numbers stand point, that should not be a surprise since only 107 FDIC institutions are over $10 billion. When the bank failures started picking up in 2009 however, there were 5 bank failures of institutions with over $10 billion in assets. One of those institutions, Colonial BancGroup had $25 billion in assets, and was eventually absorbed by BB&T. In all of 2011, the aggregated amount of banks closed by the FDIC was just over $35 billion. Look at the following chart:

Failures Assets over $10 billion

Failures Assets $1 - $10 billion

2011

0

7

2010

1

22

2009

5

23

It sure looks like the FDIC is staying away from shutting down larger institutions. Perhaps the lessons learned from Lehman Brothers, or more recently MF Global are the reasons why. What government agency wants to deal with the aftermath of allowing such a large institution to go bankrupt under their control?

So what is the issue around large institutions? Would we be better off to splinter off the top 10 institutions, and create 100's if not 1000's of additional bank brands? Various studies have been conducted that try to pinpoint the most optimal size that a bank can be before becoming inefficient. Some suggest that banks in the $10 - $50 billion asset range are just large enough to achieve economies of scale, yet small enough to remain competitive. If that was true, then why are the efficiency ratios of some of the largest banks better than the FDIC averages last quarter? If it was a given that institutions over $1 trillion dollars in assets were inefficient, how can they be doing so well on their efficiency ratios?

3Q 2011 (From FDIC.GOV)

EFFICIENCY RATIO

FDIC Average All Institutions

59.69%

Citi

52.08%

Wells Fargo

56.42%

Bank of America

64.21%

JPMC

65.81%

There is no easy answer to "too big to fail". I suggest you watch the movie, enjoy the occasional article or two on the subject, and watch for further government intervention before we actually see something happen. In addition, the FDIC simply does not have enough in the insurance fund to handle such a collapse, and with our fragile economy the last thing anyone wants to see is more chaos.

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