June 14, 2011


Small Banks, Big Banks, Giant Differences (Robert G. Wilmers, 6/13/11, Bloomberg)

Banking once was a community-based enterprise, relying on local knowledge to guide the process of gathering customer deposits and extending credit. Done well, this arrangement ensures that deposits are deployed into a diversified pool of investments, while providing depositors with liquidity and a return on their savings.

Over the past generation, however, the financial services industry changed dramatically. In 1990, the six largest financial institutions accounted for 9 percent of all U.S. domestic deposits. As of Dec. 31, 2010, the six biggest banks accounted for 36 percent of deposits.

Such concentration raises the concern that poor decisions at such outsized institutions can lead to systemic risk. But this risk is greatly magnified by the new way in which the major banks, those deemed too big to fail, are doing business today. The largest and most profitable bank holding companies have moved away from traditional lending and come to rely on speculative trading in all types of securities, derivatives, credit default swaps, mortgage-backed securities and other, even more complex and exotic financial instruments -- many of them associated with high leverage.

Such trading now is the engine of income. In 2010, the six largest bank holding companies generated $56.1 billion in trading revenue, or 74 percent of their $75.7 billion in pretax income.

Trading revenue at these institutions distinguishes them from traditional commercial banks, which aren’t typically involved in such speculative endeavors. The Big Six institutions earned more than 93 percent of the trading revenue generated by all American banks during the past two years. To say these large institutions are the same species as traditional commercial banks is akin to describing dinosaurs as reptiles -- true but profoundly misleading.

To concentration and speculation one can add another dangerous element: outsized, bonus-based executive pay. This supersized compensation, like the trading itself, is something new under the sun for bankers -- and poses serious problems for the U.S. labor market and our most talented citizens.

Consider that in 1929 compensation for employees in the financial-services industry was just 1.5 times that of the average nonfarm U.S. worker. By 2009 employees in the securities and investments sector, which includes investment banks, securities brokerages and commodities dealers, earned 3.4 times as much as an average U.S. worker.

Posted by at June 14, 2011 6:05 AM

blog comments powered by Disqus