Professors Jeremy Kress and Matthew Turk’s warning that “too-big-to-fail” megabanks are not the only source of systemic risk to the banking system has proved prescient. Shortly before its collapse on March 10, 2023, Silicon Valley Bank (SVB) had approximately $209 billion in total assets. SVB was the sixteenth largest bank in the U.S., but it still fell below the size threshold that automatically triggered an enhanced regulatory regime. Until it failed, SVB was not regulated as a “systemically important” bank because it was not big enough. Yet two days after it closed, federal regulators invoked the “systemic risk exception” after determining that they needed to rescue the uninsured depositors of SVB and the even-smaller Signature Bank to prevent destabilizing the broader financial sector.
In Too Many to Fail: Against Community Bank Deregulation, Kress and Turk foreshadow the error of equating “systemically important” with “too-big-to-fail.” The article is an incisive response to the sweeping efforts since 2010 to ease the regulatory burden on small and midsize banks, which culminated in the Economic Growth, Regulatory Relief, and Consumer Protection Act of 2018. It argues that this deregulatory push has been premised on three widely held but mistaken myths: (1) smaller banks cannot propagate systemic risk; (2) post-financial crisis reforms overly burdened smaller banks; and (3) smaller banks require special regulatory relief or advantages to compete with too-big-to-fail counterparts.
Kress and Turk make this argument in its most expansive sense, by focusing not on banks that fall just below the “systemically important” cutoff, like SVB, but rather on the smallest depository institutions: so-called community banks with less than $10 billion in assets. But even those who are unpersuaded by the full scope of their claims will agree with many of their broader insights about why smaller banks merit serious regulatory attention.
Too Many to Fail starts by establishing that the community banking sector can propagate systemic risk. In broad strokes, systemic risk exists because community banks tend to have highly correlated balance sheets and funding vulnerabilities. Because runs can spread rapidly between institutions with similar profiles, the community banking sector is particularly susceptible to concurrent failures. And a collapse of community banks en masse could well distort capital markets and disrupt the real economy. The systemic impact of small bank runs is not a mere theoretical possibility: according to the authors, the simultaneous failure of many small banks was a component of every banking crisis in American history, including 2008.
Kress and Turk next consider how systemic risk from the community banking sector ought to be regulated. Using the Dodd-Frank Act and other post-financial crisis reforms as the baseline, Kress and Turk seek to dispel the persistent concern that the regulatory framework since 2010 has been uniquely onerous for community banks. They document the ways in which policymakers “made special efforts” to design postcrisis rules to limit the regulatory burden on smaller banks and provide them with both explicit and implicit subsidies, such as reducing their contributions to the Deposit Insurance Fund, exempting banks with less than $10 billion in assets from the cap on debit card transaction fees, and curtailing the ways in which the largest banks can use their size to gain competitive advantages. On balance, they calculate, “[these accommodations] likely offset the financial drag from new prudential regulations imposed on community banks after the crisis.”
Kress and Turk’s final claim is the most expansive: community bank regulatory relief is ill advised not only because the postcrisis status quo was not excessively burdensome for community banks, but also because “community banks do not necessitate special legal treatment,” either in the form of deregulation or subsidies. In their view, regulatory advantages or relief for community banks will not meaningfully impact the current concentration of financial assets in too-big-to-fail banks, increase the availability of credit for local communities or nontraditional borrowers, or supply a necessary correction to an uneven playing field between the largest and smallest banking institutions.
There is a lot to be gained from this article, especially in the current moment. SVB’s collapse put the broader financial system at risk through the linkages that Kress and Turk describe: as word of SVB’s problems spread, other midsize banks that shared similar risk, funding, and geographic profiles began to experience significant deposit withdrawals. Signature Bank, which closed two days after SVB, reportedly lost 20% of its total deposits in a matter of hours after SVB failed. Kress and Turk’s warning that a two-tiered treatment of large and small banks could inadvertently drive risk-taking toward the less regulated sector also deserves close study, particularly in light of growing concern over smaller banks’ exposures to the turbulent cryptocurrency industry. And besides recommending the obvious conclusion of rolling back recent deregulatory initiatives, Kress and Turk also offer several practical proposals for reform, including stress tests of smaller banking sectors as a whole to identify and prevent the build-up of common vulnerabilities.
Naturally, there are also grounds for challenging some of the article’s claims. For example, do community and midsize banks, on the one hand, and the largest banking conglomerates, on the other, propagate systemic risk in different ways that require different rules? Do other distinctions between their operating models necessitate giving smaller banks some regulatory relief or subsidy? Kress and Turk document that community banks have profitably co-existed with the largest banks since 2010, but community banks were arguably only able to compete effectively because they received special legal treatment within the postcrisis framework.
There have already been numerous calls for regulatory changes since SVB’s and Signature Bank’s collapse. Too Many to Fail’s clear-eyed distillation of how smaller banks can create important systemic risks to the financial system and how those risks ought to be regulated provides a timely, important starting point for any conversation about banking reform.
