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Why The Biggest Banks Will Only Keep Getting Bigger

Many people hate the "too-big-to-fail" banks like Bank of America (NYSE: BAC) and Citigroup (NYSE: C) -- but a recent study reveals banks will only want to keep getting bigger.

This week, the New York Federal Reserve released 11 papers on the need and impact of the biggest banks. The papers visited the benefits and costs surrounding the size and complexity of the biggest banks, as well as the best ways to approach the resolution surrounding bank failures.

Big and getting bigger
Since the financial crisis in 2009, many have called for the elimination of banks designated as being too-big-to-fail, or an extension of regulation and rules which would in turn limit the potential risks posed and perhaps even incent the banks to break themselves up.

One reason behind this is the incredible growth of banks since 1991. The paper entitled Do Big Banks Have Lower Operating Costs? begins by noting in 1991, the four largest banks in the U.S. had assets equivalent to 9% of the gross domestic product in the (GDP) U.S., but that number now stands at a staggering 50%. The same is true of the deposits of Americans, where in 1994 the five largest banks held just 12% of the total deposits, whereas that number now stands at 40%:

And while many may shudder at the thought of banks only growing larger, it turns out that may be best for both banks and their customers.

The benefits of size
One of the benefits to the big banks is the implicit guaranty of being backed by the Federal Government, which one paper suggested resulted in the cost of their funding to be 0.31% less than smaller peers. However in addition to less expensive funding, Do Big Banks Have Lower Operating Costs? found every addition $1 billion in assets results in a reduction in expenses by $1 to $2 million relative to those assets.

The paper goes on to note, "the largest contributions in dollar terms come from employee compensation, premises and fixed assets, corporate overhead, and information technology and data processing," as ultimately the banks have lower costs needed to service each additional dollar in assets as they scale larger and larger.

Curiously, the benefits of size aren't only confined to the banks themselves. The paper also notes any possible limitations on the size of banks "may, in fact, increase the cost of providing banking services," which would actually result in heightened costs passed on to customers.

The takeaway
The common dialogue surrounding banking almost always suggests the best things for banks to do is shrink. Part of the reason behind this is the massive losses resulting from previous acquisitions, like the Bank of America purchase of Countrywide, and its slow efforts to reduce the tangle it found itself in.

However, as the paper suggests, there is a real benefit to banks when they add to their assets in an efficient and intelligent way. This is why the recent acquisition of branches in Chicago by US Bancorp has to be applauded, as the bank will ultimately be able to add to its top and bottom line results in an efficient and cost-effective way.

While the results from the Federal Reserve by no means suggest every instance of a bank getting bigger is a good thing, when it comes to US Bancorp, one has to wonder if more acquisitions are on the horizon, which will be a benefit to all.

The biggest change you never saw coming
Even if they may make sense, do you hate the "too-big-to-fail" banks? If you're like most Americans, chances are good that you answered yes to that question. While that's not great news for consumers, it certainly creates opportunity for savvy investors. That's because there's a brand-new company that's revolutionizing banking, and is poised to kill the hated traditional brick-and-mortar banking model. And amazingly, despite its rapid growth, this company is still flying under the radar of Wall Street. To learn about about this company, click here to access our new special free report.

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  • Report this Comment On March 26, 2014, at 9:05 AM, jdmeck wrote:

    All very obvious, logical and good for the customers, but you can bet all the liberals will be complaining and stating otherwise.

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Patrick Morris

After a few stints in banking and corporate finance, Patrick joined the Motley Fool as a writer covering the financial sector. He's scaled back his everyday writing a bit, but he's always happy to opine on the latest headline news surrounding Berkshire Hathaway, Warren Buffett and all things personal finance.

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