Executive Summary and Introduction
The 2008 financial crisis threw into sharp relief the issue of “too-big-to-fail” (TBTF)—the
challenge posed by financial institutions that were bailed out on concerns that their failure
would cause damage to the rest of the financial system and the overall economy. Since
then, policymakers and regulators have wrestled with how to address this problem. The
Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank) put in
place a series of measures to address the policy challenges of TBTF firms, including rules to
enhance prudential supervision of individual institutions and reforms aimed at improving
oversight of the overall financial system. Regulators have since agreed at a global level to
yet-tougher prudential standards for large financial companies. Dodd-Frank also established
a new legal authority to resolve a large and complex financial institution without the need
for taxpayer support or further disruption to the financial system.
Have these sweeping reforms have gone far enough in addressing the policy challenge of
large, complex financial institutions? If they have not, then further measures would be
appropriate, including breaking up or shrinking the size of large financial institutions. Such
efforts would aim to eliminate perceived government subsidies to large banks that might
support their size, and thereby to lessen the purported negative impacts of problems
associated with these institutions. But such actions would impose costs, on top of those
already associated with the steps taken to date. These costs must be weighed against
benefits in order to decide on the appropriate course of action.
This paper, a product of the Bipartisan Policy Center’s Financial Regulatory Reform
Initiative, assesses those costs and benefits. What would be the consequences of breaking
up the country’s biggest banks? What would dramatically shrinking their size mean for the
financial sector, the U.S. economy, and the customers of these institutions? How would such
a strategy work? This paper seeks to answer these important questions. We conclude that
the reforms undertaken since the financial crisis have gone a long way toward addressing
the TBTF issue. Proposals to break up major financial institutions entail greater costs than
the benefits they would provide and are potentially outright counterproductive. It would be
better to allow Dodd-Frank and other U.S. and global reforms to work as intended, rather
than to break up the largest banks. Indeed, if Dodd-Frank works as intended, then there is
no need for a break up.
We came to this conclusion for several reasons. First, Dodd-Frank has made considerable
progress in addressing the TBTF problem by creating a new legal authority to resolve a large
and complex institution, potentially allowing any institution to fail without triggering a collapse of the financial system. Market expectations of future government rescues have
responded to these and other prudential regulatory reforms, including with a reduction in
the cost-of-funding advantage for large banks based in part on diminished expectations of
future government support. Moreover, if there is any remaining funding advantage, this
appears likely to be counterbalanced by enhanced prudential requirements placed on large
banks. These include higher capital requirements and annual stress tests, alongside
additional capital mandates and new liquidity and asset-liability matching requirements
agreed to by regulators through the international Basel III accord.
In addition, Dodd-Frank permits regulators to restrict the activities of financial institutions
they deem to pose a “grave threat” to the U.S. financial system or to force such firms to
divest assets. Dodd-Frank also caps the size of large banks at 10 percent of total U.S.
consolidated financial liabilities, which prevents the largest institutions from growing
through mergers and acquisitions.
Taken together, these reforms have transformed the landscape for large financial
institutions. As Treasury Secretary Jack Lew put it: “Dodd-Frank ended ‘too big to fail’ as a
matter of law; tough rules are now in place to make sure banks have the capital to absorb
their own losses; monitoring through stress tests in underway; and resolution authorities
and plans are in place. There is a growing recognition of these changes, and market
analysts are now factoring them into their assumptions.”
Second, breaking up the country’s largest financial institutions would not be a panacea.
While there are potential costs to TBTF firms, a breakup of the largest financial institutions
would reduce the value that they provide for the economy, businesses, and consumers.
Recent research points to significant economies of scale and scope at large financial
institutions, leading to efficiencies for businesses and consumers. Consumers and
businesses have responded, with some evidence suggesting they are voting with their feet
and choosing to form relationships with large institutions. Large, globally active banks
facilitate international trade, spread socially beneficial innovations, and promote economic
This is not to dismiss all concerns regarding large institutions. There are legitimate worries
that some large, complex institutions may be “too big to manage,” and a number of large
banks were among those that engaged in dangerous activities and practices in the run-up to
the crisis. However, Dodd-Frank has alternative solutions to address these problems. It is
also important to place the size argument in context. The U.S. banking sector is far less
concentrated than banks in other developed countries and even compared with other
industries in the United States. In addition to the competitive pressure from small- and
medium-sized banks across many business lines, global banks—especially the largest
banks—provide further competitive pressure on large U.S. banks, to the benefit of savers
and borrowers alike.
Third, the reality is that a breakup would be hard to do. Among the many difficult issues
that would need to be addressed for any breakup plan to succeed would be how to divide the company’s assets, debts, and customers among its successor institutions. Policies that
would break up large banks must include a plan for how such a transformation would occur
and take into account the significant transition costs of a breakup, including disruptions to
existing customer relationships.
Finally, there is little reason to believe that breaking up the largest institutions would reduce
risks in the financial system over the long-term. Breaking up an institution with $2 trillion in
assets would not result in scores of easy-to-resolve small institutions. Instead, it likely
would result in four or five successor entities, engaged in similar activities as their larger
predecessor, but still operating at a size of $400 billion to $500 billion each. Breaking up the
biggest banks, in other words, may not make the financial system any more stable. In fact,
it is possible that a financial system with many more banks of a size just below the
threshold for a breakup would be riskier, not safer.
This paper is not intended to be the final word on the complicated issue of addressing large,
complex financial firms. Instead, it aims to illuminate some of the key policy questions at
the heart of this important policy debate.