A customer stands outside Silicon Valley Bank's shuttered headquarters in March. Under the original Dodd-Frank Act, the bank would have been subject to stronger oversight. Justin Sullivan/Getty Images
I've Always Wondered ...

When should a bank be considered “too big to fail”?

Janet Nguyen Jun 16, 2023
A customer stands outside Silicon Valley Bank's shuttered headquarters in March. Under the original Dodd-Frank Act, the bank would have been subject to stronger oversight. Justin Sullivan/Getty Images

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Reader George Quaiver from Papillion, Nebraska, writes: 

I wonder why the Dodd-Frank Act puts a dividing line at $250 billion. 

In 2010, following what is sometimes called the Great Financial Crisis, lawmakers passed the Dodd-Frank Act, which aimed to make the banking system safer by subjecting financial institutions with more than $50 billion in assets to certain oversight requirements. A bank’s assets include cash, securities and loans that earn interest. 

These larger entities had to, for example, maintain greater liquidity and develop “living wills” or plans showing how they would resolve “material financial distress” or even failure. 

They also faced stress tests conducted by the Federal Reserve — a way of determining whether the bank could handle an economic downturn. Which is akin to, as banking analyst Mike Mayo once described it, a restaurant inspection. 

Some banks are regarded as “too big to fail,” in other words, so significant to the system that their failure could trigger widespread economic damage. Thus the need for regulation and oversight. 

But in 2018, under the Economic Growth, Regulatory Relief, and Consumer Protection Act, the threshold for these additional regulations rose, applying to banks with more than $250 billion in assets — five times the previous standard.

One major factor: lobbying 

Kathryn Judge, a professor at Columbia Law School, noted that all banks are subject to some capital and liquidity rules. And while smaller banks are not required to undergo the same rigorous stress testing as bigger banks, many do engage in the practice.

But under Dodd-Frank, larger banks were subject to more enhanced prudential standards, Judge explained. 

Experts say it can be difficult to assess where to draw the line. 

On one hand, you have small community banks, which Judge said don’t pose threats to the financial system’s stability and shouldn’t be burdened by overly strict rules. That’s why they usually encounter more modest regulation and supervision. On the other, there are institutions with recognizable names, like JPMorgan Chase, that are considered too big to fail. 

But how to regulate those between the two echelons?

As Judge explained, regional and midsize banks didn’t want to be monitored with a heavy hand.

One driving force behind the increased threshold was simply lobbying. “After Dodd-Frank set the threshold at $50 billion, they said, ‘Look, this is too much for us,’” Judge said.

“Part of what clearly happened here is the regional banks that were subject to the enhanced prudential standards told their members of Congress, ‘We don’t pose the same type of threat as the larger banks, and we should be subject to less stringent regulation.’”

These banks also argued that relaxed regulation would help them lend, thus stimulating the economy. 

For banks on the smaller side of the scale, it can be hard to keep pace with regulatory demands, said Kim Pernell, an economic and organizational sociologist at the University of Texas at Austin. 

When banks submit the results of a stress test to regulators, it requires “massive amounts of paperwork and analysis,” Pernell said. 

“JPMorgan’s got a whole bureaucratic team devoted to regulatory compliance, and they can pay all those people,” she added. 

The Dodd-Frank rollback also occurred under the Donald Trump administration, when the Republican Party controlled both the White House and Congress. 

“There was a lot of division around Dodd-Frank along partisan lines — a lot of support among the Democrats, very little support among the Republicans,” Judge said. “So when the Trump administration took over, there was an expectation that there might be some shifts.”

While there has been partisan divide over Dodd-Frank, the 2018 reforms were able to garner support from some Democrats.

But there are caveats in the changes made to Dodd-Frank. While the threshold for annual stress tests was raised to $250 billion, those with $100 billion to $250 billion in assets have to participate every other year. 

What did we learn from the reforms? 

Judge would like to see a lower threshold than $250 billion, she said, although she supported some elements of the 2018 law that she thinks helped community banks. 

Earlier this year, Silicon Valley Bank shut down after it suffered a run on deposits, with Signature Bank and First Republic following suit. 

While we don’t know for sure if the original Dodd-Frank rules could have prevented the SVB meltdown, experts say the rollbacks didn’t help. 

Pernell said tighter liquidity requirements mean the banks could have had more cash available to pay depositors. Experts have told Marketplace that institutions the size of Silicon Valley Bank would have also been subject to more frequent stress tests. However, some put more of the blame on the bank’s management.

Pernell said she sometimes thinks we focus too much on the largest banks and ensuring that they comply with the strictest of standards. 

“I feel like we’re kind of taking our eyes off of what smaller banks are doing because we think their failure doesn’t quite present such a systemic risk,” Pernell said. “But in today’s financial system, where everything is moving so quickly and it’s so hyperconnected, I’m just not sure that there are a lot of financial institutions whose failures don’t present a systemic risk.” 

Silicon Valley Bank, for instance, showed that regional institutions can threaten the larger financial system. Federal regulators guaranteed all deposits at Silicon Valley Bank, even uninsured amounts, to prevent bank runs elsewhere. 

“I think the hard part is we’re all just kind of winging it,” Pernell said. “What should count as a systemically important financial institution? Well, that definition changes as we learn more about problems in our system.”

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