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Why The Biggest Banks Will Only Keep Getting Bigger

By Patrick Morris – Mar 26, 2014 at 7:30AM

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While Bank of America and Citigroup have rightfully been shedding underperforming and risky assets, one paper reveals why U.S. Bancorp has made the right move in acquiring assets.

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.

Patrick Morris owns shares of Bank of America and US Bancorp. The Motley Fool recommends Bank of America. The Motley Fool owns shares of Bank of America and Citigroup. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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