American Enterprise Institute Roundtable: Government Policies Reshape the Banking System

The U.S. federal government response to the 2008 financial crisis, including new laws, prudential regulations, and Federal Reserve monetary policies, has left a lasting impact on the U.S. banking industry. Along with a nearly 50% drop in the number of independent depository institutions since 2000, the industry has become much more concentrated in a few large “systemically important” institutions. At the same time, the largest banks have responded to incentives provided by increased regulatory requirements and the Fed's zero interest rate policy by reducing their lending to the private sector and increasing both their real estate holdings and their reliance on deposits to fund them. For the five well‐known banking scholars who take part in this AEI‐organized discussion, such recent changes have troubling consequences for both the industry and the broader economy. After economic historian Richard Sylla describes a 100‐year movement of U.S. banking toward a system characterized by a few large banks with extensive branch systems, bank authority Alex Pollock points to the growing role and influence of the Federal Reserve and government‐sponsored enterprises in the “banking credit system.” And bank consultant Bert Ely points to a number of large and growing industry risks. Along with their unprecedented real estate holdings, Ely notes the massive holdings of U.S. government debt by both the Fed—which is identified as having an enormous interest rate mismatch and exposure—and the banks it supervises. At the same time, low interest rates have been squeezing banks’ margins and reducing their capital cushions to absorb losses that may arise from the pandemic. Charles Calomiris, who recently stepped down as Chief Economist of the OCC, views such extreme consolidation as an unhealthy trend—one that, along with banks’ growing dependency on deposits (and hence government guarantees and support) and reliance on real estate lending have become the main components of a “three‐legged stool” that are making large banks and banking systems throughout the world ever more subject to government influence. As a result of such dependence, the U.S. banking system is becoming more vulnerable to economy‐wide “shocks” such as the expected effects of a sharp increase in interest rates or a sudden plummeting of real estate prices. As Calomiris argued in his famous book (with Stephen Haber), U.S. banks—and indeed banks in most nations, thanks to “political bargains” with their governments that seem inevitable—appear to be becoming ever more “fragile by design.”