GAO Can’t Conclude Large Banks Have Lower Funding Costs Than Smaller Banks

The Government Accountability Office, or GAO, was asked to review the benefits that the largest bank holding companies (those with more than $500 billion in assets) have received from perceived government support. In connection with that review, GAO analyzed the relationship between a bank holding company’s size and its funding costs, taking into account a broad set of other factors that can influence funding costs. As part of the analysis GAO reviewed selected studies that estimated funding cost differences between large and small financial institutions that could be associated with the perception that some institutions are too big to fail. Studies GAO reviewed generally found that the largest financial institutions had lower funding costs during the 2007-2009 financial crisis but that the difference between the funding costs of the largest and smaller institutions has since declined. According to GAO these empirical analyses contain a number of limitations that could reduce their validity or applicability to U.S. bank holding companies. For example, some studies used credit ratings which provide only an indirect measure of funding costs.

GAO said its analysis, which addresses some limitations of these studies, suggests that large bank holding companies had lower funding costs than smaller ones during the financial crisis but provides mixed evidence of such advantages in recent years. However, GAO believes most models suggest that such advantages may have declined or reversed. GAO developed a series of statistical models that estimate the relationship between bank holding companies’ bond funding costs and their size or systemic importance, controlling for other drivers of bond funding costs, such as bank holding company credit risk.

GAO stated all of its models found that larger bank holding companies had lower bond funding costs than smaller ones in 2008 and 2009, while more than half of the models found that larger bank holding companies had higher bond funding costs than smaller ones in 2011 through 2013, given the average level of credit risk each year. However, the models’ comparisons of bond funding costs for bank holding companies of different sizes varied depending on the level of credit risk.

GAO’s analysis builds on certain aspects of prior studies, but important limitations remain and GAO believes these results should be interpreted with caution. GAO’s further believes its estimates of differences in funding costs reflect a combination of several factors, including investors’ beliefs about the likelihood a bank holding company will fail and the likelihood it will be rescued by the government if it fails, and cannot precisely identify the influence of each factor. According to GAO, these estimates may reflect factors other than investors’ beliefs about the likelihood of government support and may also reflect differences in the characteristics of bank holding companies that do and do not issue bonds. Finally GAO points out that its estimates, like all past estimates, are not indicative of future trends.

Topics:  Bank Holding Company, Banking Sector, Banks, Funding, GAO

Published In: Finance & Banking Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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