Over the Line: Asset Thresholds in Bank Regulation

"As of December 31, 2020, there were over 5,000 banks in the United States. While certain kinds of banks may be similar to each other, the industry as a whole is made of up institutions that differ in a variety of ways, in some ways quite drastically. How concentrated a bank is in loan making, how concentrated that lending is in specific loan types or geographic markets, how many other financial services the bank provides, and how much risk it is willing to take on are just a few characteristics across which banks may differ significantly. Perhaps the most striking disparity across the industry is bank size, typically measured as the value of the assets a bank owns.

Nearly a fifth of banks hold less than $100 million in assets, and the industry median is about $300 million. Meanwhile, the largest U.S. bank has over $3 trillion in assets, with three others over or near $2 trillion. Relative to large banks, small banks also tend to focus more on traditional commercial bank activities such as loan making and deposit taking; be less or not at all involved in other activities such as securities dealing and derivatives; have fewer resources to dedicate to regulatory compliance; and individually pose less or no risk to the stability of the financial system. For these reasons, there is general consensus that bank regulations should be tailored to account for bank differences, although questions over how much regulation should be tightened or relaxed for different groups of banks and to exactly which banks the changes should apply are matters of perennial debate.

Tailoring bank regulation in general produces certain benefits (e.g., achieving the goals of a regulation at less cost; not subjecting a group of banks to needless, costly regulation; freeing small bank resources for lending) but at certain costs (e.g., potential increased risk of failure for banks that qualify for relatively lax regulation, creating the opportunity for regulatory arbitrage). Furthermore, the reliance on asset thresholds has strengths and weaknesses. As a simple criterion, it makes regulatory treatment objective and transparent and minimizes opportunity for regulatory arbitrage. However, when application of a rule relies on a single, binary criterion, it can create distortionary “cliff” effects..."
Bank regulations