February 2013 Banking On Our Future: The Value Of Big Banks In A Global Key Findings: Economy • U.S. banks are already smaller and safer than their global We are no longer living in the times of George Bailey. Big banks competitors are not only competing with the Mr. Potters of the next town over, but with large and powerful institutions from around the • The loan syndication market is globe. no substitute for big, global Imagine a scene in "It's a Wonderful Life" where a company asks banks George Bailey to provide a multibillion dollar line of credit or raise hundreds of millions of dollars in a couple of days to help a • In the event of a break up, the company meet its capital needs. Add to that a scenario where the global competitive landscape companies were operating across foreign countries with multiple will rebalance in favor of currencies and regulatory regimes. foreign banks and the shadow banking sector The truth is that the U.S. needs both large multinational banks and small community banks in order to service the needs of the U.S. and global economies, provided that they are run safely with • Ultimately, breaking up U.S. sufficient capital and liquidity appropriate to their business banks will not improve the operations. safety of the global financial sector and would reduce U.S. This paper is divided into two broad sections. The first section influence over the financial examines oft-neglected facts about the largest U.S. banks in the break up the banks debate: the value of large banks to the global sector globally economy and their growth over time, the dramatic improvements in safety and soundness over the past three years, and the context of international competition. The second section explores the consequences of ignoring these facts by breaking up the banks. Patrick Sims, Specifically, which financial institutions will meet the needs of the Director of Research U.S. and global economies if the largest U.S. banks are broken up? Hamilton Place Strategies In the event the largest U.S. banks are broken up, the global 805 15th St NW competitive landscape will rebalance in favor of foreign banks and the nonbank financial sector. This will place U.S. banks at a Suite 700 competitive disadvantage for banking services and is likely to have Washington, DC 20005 negative unintended consequences on the control and flow of (202) 822-1205 credit in the economy. In a breakup scenario, large European, Japanese, and Canadian banks, will gain market share in the short-run. In the long-run, Chinese banks, and other growing nonbank financial institutions in the shadow banking sector, stand to gain the most. The U.S. regulatory system, and the economy as a whole, benefits from a large, domestic-based financial industry. Moreover, U.S. regulators have more authority over U.S. banks than they do over foreign banks and the shadow banking sector. In a world fraught with risk, it is to America's advantage to have proximate control of capital, and safety and soundness, rather than to cede its authority to countries and institutions that may “Ultimately, breaking up U.S. have conflicting interests. banks will not improve the safety of the global financial Ultimately, breaking up U.S. banks will not improve the safety of the global sector and would reduce U.S. financial sector and would reduce U.S. influence over the financial influence over the financial sector sector globally.” globally. Section 1: Big Banks Today In The Global Economy The rise of big banks over the past several decades reflects dramatic growth and increased interconnectedness in the global economy and its financial needs. Global banks act as a platform for U.S. multinational companies and U.S. investors to manage and execute various financial management strategies. Recent regulation has helped address many concerns brought about from the recent financial crisis. Data shows that the U.S. financial sector is dramatically safer than pre-crisis. Dodd-Frank reform and Basel III have led to improvements in safety and soundness. The creation of "living wills" provides an outline for how a firm can fail without damaging the broader economy, and new legal authority for liquidating failing firms now exists as a viable option for regulators. New agencies exist to explicitly monitor systemic risk in the financial sector, provide ongoing oversight, and thought leadership in the field. The regulatory overhaul is far from finished, as new rules have yet to be implemented. All these developments have and will continue to contribute to a less crisis-prone financial sector where no firm is too big to unwind. The Global Economy And Its Financial Needs Have Grown Exponentially The discussion surrounding breaking up the banks often downplays the value of big, global banks to the U.S. and global economy. Critics have painted the picture of an out of control, large banking sector that must be reined in. Yet, the data shows that the U.S. banking sector has actually grown proportionately with the rest of the Hamilton Place Strategies | 2 economy (Exhibit 1). U.S. exports and the S&P 500 have both grown at the same rate as the assets of U.S. banks over the past two decades. Exhibit!1 ! GROWTH OF THE U.S. BANKING SYSTEM IS CLOSELY TIED TO GROWTH OF THE U.S. ECONOMY! Indexed Growth Rates! • S&P 500 = 378.8%! S&P 500! U.S. Exports! Bank Assets*! • U.S. Exports = 393.0%! • U.S. Banks = 379.8%! 450! ! 400! ! 350! 300! 250! 200! Indexed (100 =1990 Levels) Indexed 150! 100! 1990! 1992! 1994! 1996! 1998! 2000! 2002! 2004! 2006! 2008! 2010! 2012! Source: Federal Reserve Bank of St. Louis ! *U.S. Commercial Banks! Much of the expansion came from large U.S. companies that now employ roughly 20 percent of all U.S. workers. Over the past decade, non-U.S. revenue as a percent of total revenue increased by 14 percent for the top 50 companies in the U.S.1 Large companies like Wal-Mart now receive more than 20 percent of their revenues from foreign countries. Other well-known multinationals, such as Ford Motors, receive roughly 40 percent, while oil and gas producers, such as Exxon Mobile, receive well more than 50 percent of its revenues from countries outside of the U.S. According to the "World Investment Report," foreign direct investment (FDI) from developed countries like the U.S. rose 23 percent in 2011. In addition, countries outside the U.S. are also heavily investing in U.S. companies; for example, Japanese firms doubled mergers and acquisitions of U.S. and European companies over the same period.2 Some critics say the problem is not the growth in the banking sector itself, but the concentration of assets among individual banks. During the recent financial crisis, some large banks consolidated their institutions with failed banks and other institutions that seemed a bargain at the time. Thus, the narrative states that through government subsidies and government-supported mergers, individual banks that were “too-big-to-fail” got even bigger. 1 "Scaled to Serve: The Role of Commercial Banks in the U.S. Economy," The Clearing House, July 2012. 2 "World Investment Report 2012," UNCTAD, July 2012. Hamilton Place Strategies | 3 Many banks did grow over the last several decades; however, growth of the largest U.S. banks did not outpace the growth of the global economy. For example, in a Milken Institute working paper titled "Just How Big Is the Too Big to Fail Problem?" Barth, Prabha, and Swagel analyze the composition of the world's largest banks over time. Based on the assets of the world's 50 largest banks, big U.S. banks had a global market share of 40 percent in 1970, the largest share at the time, totaling roughly $170 billion. That quickly changed. Due to increased international competition and the expansion of global finance, by 1990 the market share of big U.S. banks decreased to a mere three percent of the top 50. This does not mean U.S. banks lost assets over this period. On the contrary, the largest U.S. banks increased their holdings to $297 billion by 1990; “U.S. banks were at a however, big U.S. banks were not competitive disadvantage in on the receiving-end of the global expansion from that period. the global economy and Essentially, U.S. banks were at a rapidly losing market share to competitive disadvantage in the banks throughout Europe and global economy and rapidly losing market share to banks throughout Japan.” Europe and Japan.3 Although the global economy was growing at a rapid rate prior to 1990, the growth that occurred post-1990 makes the prior expansion look miniscule. New data from 2011 shows that the biggest U.S. banks have regained global market share, however, not to the levels seen since 1970. The biggest U.S. banks now hold 15 percent of the assets of the top 50 banks, representing $9.8 trillion. And although the U.S. economy is larger than all others, large U.S. bank market share falls in line with those of most developed economies. This is in line with the market shares of other developed economies. This data reflects that big U.S. banks face a highly competitive global industry, and although their size has increased over the past few decades, size correlates closely with that of the growth in the economy. Globalization Of The Economy And Financial Assets What caused such large growth in the banking sector? Globalization - the world economy and its global financial needs got bigger.