Bank Size Not Enough to Measure Its Systemic Risk

If you have driven a car, you might have more insight into bank regulation than you think.

The risk posed by a vehicle is in part based on its size. A mistake by a truck driver can cause more damage than a mistake by the average motorist. However, other factors also determine risk. An alert trucker driving on an empty highway poses much less risk than a distracted motorist driving outside a crowded school.

Banks and bank regulation similarly have many factors that determine risk.

In a recent report, the Office of Financial Research (OFR) argues that “size alone is not sufficient to identify systemically important banks.” OFR says a multi-factor approach in determining systemically important banks would be an improvement over the current approach that is based entirely on asset size.

BPC has made a similar argument in the past. The Dodd-Frank Act subjects bank holding companies with more than $50 billion in assets to heightened regulatory standards. BPC has supported raising this threshold and making it presumptive, so size is not the only determinant of a bank’s systemic risk. A bank above this threshold is assumed systemically important and one below this threshold is considered not systemically important. However, this presumption can be overturned based on other factors including interconnectedness, substitutability, leverage, liquidity risk, and maturity mismatch.

There is already bipartisan support for measures that move beyond just size in determining the systemic risk of a bank holding company. Rep. Blaine Luetkemeyer (R-MO) has introduced a bill with 16 Democratic and 53 Republican co-sponsors that would apply a more comprehensive approach to measuring systemic risk by looking at factors including interconnectedness, substitutability, global cross-jurisdictional activity, and complexity—these factors are the same as those used by the Basel Committee on Banking Supervision for measuring the risk of “global systemically important banks.” Sen. David Perdue (R-GA) and Sen. Claire McCaskill (D-MO) have introduced a similar bill in the Senate.

The Office of Financial Research argues that ‘size alone is not sufficient to identify systemically important banks.’

A more tailored approach to bank regulation can provide regulatory relief for less risky banks, while allowing regulators to focus their resources on banks that are most likely to pose systemic risk. This can help Main Street small businesses and entrepreneurs by making capital more accessible, and ensure regulation is better tailored to address the systemic risks posed by the banking sector.

OFR is correct to point out that size alone is not sufficient in identifying systemic risk at banks and many policymakers seem to agree. BPC sees this as a welcome development and a chance for bipartisan improvements to post-crisis financial reform.