Why Are Big Banks Getting Bigger?
Claremont Colleges – Claremont McKenna College
David Einhorn’s Greenlight had a strong fourth quarter; Gains on Neubase Therapeutics [Q4 Letter]
David Einhorn's Greenlight Capital was up 5.2% in 2020, underperforming the S&P 500's 18.4% return. For the fourth quarter, the fund was up 25%, which was its best quarterly result ever. Longs contributed 42% during the fourth quarter, while shorts detracted 15% and macro detracted 1%. Q4 2020 hedge fund letters, conferences and more Growth Read More
Federal Reserve Bank of Dallas
February 18, 2016
The U.S. banking sector has become substantially more concentrated since the 1990s, raising questions about both the causes and implications of this consolidation. We address these questions using nonparametric empirical methods that characterize dynamic power law distributions in terms of two shaping factors – the reversion rates (a measure of cross-sectional mean reversion) and idiosyncratic volatilities of assets for different size-ranked banks. Using quarterly data for subsidiary commercial banks and thrifts and their parent bank-holding companies, we show that the greater concentration of U.S. bank-holding company assets is a result of lower mean reversion, a result consistent with policy changes such as interstate branching deregulation and the repeal of Glass-Steagall. In contrast, the greater concentration of both U.S. commercial bank and thrift assets is a result of higher idiosyncratic volatility, yet, idiosyncratic volatility of parent bank-holding company assets fell. This contrast suggests that diversification through non-banking activities has reduced the idiosyncratic asset volatilities of the largest bank-holding companies and affected systemic risk.
Why Are Big Banks Getting Bigger? – Introduction
The U.S. banking sector has undergone a tremendous transformation over the last half century. A small group of the largest banks holds more assets than ever before, a trend that accelerated after large-scale bank deregulation in the late 1990s (Kroszner and Strahan, 1999; Kroszner and Strahan, 2014).1 Indeed, the ten largest bank-holding companies (BHCs) controlled about 70 percent of total banking assets by 2010 (Figure 1). The Great Recession and Financial Crisis, characterized by the spectacular failures of large financial institutions such as Lehman Brothers and Bear Stearns, raise a number of concerns about this rise in bank asset concentration. First, greater asset concentration may reflect fundamental changes in the nature of banking activities, such as a shift away from traditional banking towards non-banking activities within the largest financial institutions (DeYoung and Torna, 2013). This shift may contribute to added risk within financial intermediaries and hence within the banking system as a whole. Second, greater asset concentration could alter the network structure of the financial system, leading to more financial instability through greater exposure to shocks affecting large and systemically important financial institutions (SIFIs). A growing literature has emphasized the potential for idiosyncratic, firm-level shocks to have significant macroeconomic consequences (Gabaix, 2011), especially in industries such as banking where interlinkages and contagion between entities are common (Acemoglu, Carvalho, Ozdaglar, and Tahbaz-Salehi, 2012; Caballero and Simsek, 2013).
We explore the causes and implications of rising U.S. bank asset concentration using nonparametric empirical methods to describe the dynamics of the distribution of banking assets for U.S. commercial banks, thrifts, and BHCs. Our general methods, which are new to economics but are well-established in statistics, characterize the stationary distribution of bank assets in terms of only two econometric factors—the reversion rates (a measure of the rate of cross-sectional mean reversion) and idiosyncratic volatilities of bank assets.2 In particular, our new techniques yield an asymptotic statistical identity in which the distribution of bank assets is described by the relationship
This identity, which obtains under minimal assumptions, shows that bank asset concentration is decreasing in reversion rates and increasing in idiosyncratic volatility. We are thus able to simultaneously investigate changes in both idiosyncratic bank asset volatility and the power law structure of the bank size distribution in a unified and robust econometric framework. How do we interpret these two shaping econometric factors? The reversion rates of bank assets measure the different growth rates of different sized banks and encompass economic mechanisms such as regulatory and competition policy in the banking sector (Kroszner and Strahan, 1999; Kroszner and Strahan, 2014) as well as preferences, constraints, and strategic choices that drive asset growth for different sized banks (Corbae and D’Erasmo, 2013). The idiosyncratic asset volatilities measure the intensity of firm-specific shocks. These include unanticipated changes to bank liabilities and defaults on bank assets caused by shocks to borrowers’ production technologies (Corbae and D’Erasmo, 2013). One of our novel contributions is to measure the changing magnitude of these shocks for both BHCs and their subsidiary commercial banks and thrifts. This exercise reveals the changing nature of diversification through non-banking activities for the largest U.S. financial institutions. It also reveals changes in one important potential source of contagion and systemic risk—idiosyncratic volatility (Acemoglu et al., 2012).
Using quarterly data on the assets of commercial banks, thrifts, and their parent BHCs, we estimate reversion rates and idiosyncratic volatilities of bank assets over a period during which the size distribution of these three categories of financial intermediaries became more concentrated. Our estimates reveal that the cause of higher concentration among both U.S. commercial banks and thrifts after the mid-1990s is an increase in idiosyncratic asset volatility, especially for the largest banks and thrifts. In contrast, we find that the primary driver of higher concentration among BHCs during this same time period is a fall in cross-sectional mean reversion as measured by the reversion rates of bank assets—the idiosyncratic volatilities of BHCs’ total asset holdings actually decreased after the mid-1990s.
See full PDF below.