Bigger banks are good for bankers but not customers

Dawn Kissi | Sep 16, 2021

Sections Finance

Big banks have remained big, even in the wake of the 2008–09 financial crisis and discussions about too-big-to-fail institutions. The top five US banks had, a decade after the crisis began, approximately 46 percent of US banking assets, slightly more than they’d had before the crisis, according to the World Bank. 

As big banks argue that they provide advantages such as efficiency that outweigh any problems or systemic risks, regulators and policy makers have allowed the growth to continue. But research by Chicago Booth’s Kilian Huber suggests that bigger banks don’t provide many of the advantages claimed—and that consolidation may be motivated by higher salaries for bankers. 

Researchers have long explored the repercussions of bank size, with mixed results. Some papers suggest that bigger banks may be more efficient and more stable than their smaller counterparts, and ultimately help their business customers grow faster. Others argue that big, complex banks may hurt borrower growth and increase systemic risk. 

“Given the ambiguous theoretical predictions, the effect of bank size on firm growth is an empirical question,” writes Huber, who analyzed data from postwar Germany to produce an answer. 

After World War II, the Allies broke up Germany’s three biggest banks, arguing that these institutions had contributed to the Nazi war effort. Commerzbank, Deutsche Bank, and Dresdner Bank were split into 30 independent “treated” banks, which were later permitted to reconsolidate. A first round of reform, in 1952, led to nine banks from 30. A second round, in 1957, produced the same big three that had existed before. Most banking in Germany was relationship based over this period, so customers mostly stuck with their banks through any changes.

How did those treated banks and their customers perform relative to smaller banks not subject to the reforms? Huber found a host of potentially useful data—including public companies’ employment, revenue, assets, liabilities, and bank debt—in several historical volumes, which he digitized, making it possible for him and subsequent researchers to more easily access and analyze the information. His data set includes the bank relationships of about 5,900 companies, the employment growth of 2,300 companies, and balance-sheet variables of 400 companies. 

Before 1952, the trajectory at many companies was largely the same, he observes, but that changed after the first set of reforms. Loan and deposit growth slowed more at the treated banks relative to the others. Consolidations didn’t make banks more cost-efficient or profitable. 

As for customers, as their banks grew, the rates at which they added bank debt, employees, and revenue per worker didn’t improve, and small and young companies actually did worse. The same was true for municipalities with more exposure to consolidating banks. “These findings show that increased bank size does not always generate improvements in bank efficiency or firm growth, in contrast to leading theories,” Huber writes. “Furthermore, opaque (small, young, low-collateral) firms grew more slowly after their banks got bigger, consistent with the view that bigger banks are worse at processing soft information.”

While borrowers didn’t benefit, banks themselves did, the research suggests. When banks combined, managers’ pay rose, and the managers received more media attention, which they may have enjoyed, Huber writes.  

“The results from different datasets and analyses all paint a consistent picture: bigger banks did not improve the growth of borrowers,” he concludes. “The experience from postwar Germany highlights that the efficiency-enhancing mechanisms do not always outweigh the harmful effects.”