One of the problems Dodd-Frank set out to tackle was banks that were 'too big to fail' – yet in the years since the fall of Lehman Brothers, many banks have become even bigger. New research asks why.
Research by University of Pennsylvania accounting professor, Allison Nicoletti, suggests that the additional compliance costs under the Dodd-Frank Wall Street Reform and Consumer Protection Act have led to consolidation in the US banking sector. Dodd-Frank imposes significant compliance costs for banks above certain asset thresholds – for example, the requirements vary according to whether banks have assets exceeding $10 billion, $50 billion or $250 billion. The research argues that the banks affected became more likely to engage in acquisition after Dodd-Frank came into force in 2010 and were more likely to pay larger deal premiums for those acquisitions.
The paper – Regulatory Thresholds and Mergers and Acquisitions in the Banking Industry – written by Allison Nicoletti, along with Hailey Ballew of Ohio State University and Michael Iselin from the University of Minnesota, examines how regulations with asset thresholds affect bank acquisition activity – and whether banks with more than $10 billion in assets might be incentivised to engage in an acquisition. Nicoletti told Knowledge@Wharton: “The reason why that’s a viable strategy is because it allows banks to increase their asset size quickly and, hopefully, grow those income-earning assets.”
She continues: “When performance is negatively affected, banks engage in an acquisition. These fixed costs that are associated with the new requirements are spread over this larger asset base, and that negative effect to performance will be somewhat mitigated.”
Big banks getting bigger
Of around 5,900 banks in the US, only 100 or so have assets greater than $10 billion, so the aspect of the Dodd-Frank regulation examined in the paper is really only for the top 2 per cent of the US's banks.
Many of the US's largest banks are bigger than they were before the financial crisis. This article in Fortune states: “The six largest banks in the nation now have 67% of all the assets in the U.S. financial system, according to bank research firm SNL Financial. That amounts to $9.6 trillion, up 37% from five years ago.”
The researcher say that regulators that are typically concerned about consolidation should be aware of this issue.
CTMfile take: This is interesting research, since there has been much criticism of Dodd-Frank from those who say it goes too far in restricting the ability of banks to trade freely, as well as those who say it has not been effective in dealing with banks that are 'too big to fail'.
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