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Size is Overrated

This month, in the guise of supporting community banks, the U.S. Senate passed a bill (S.2155) that eases regulation of large banks. We share the critics’ views that this wide-ranging dilution of existing regulation will reduce the resilience of the U.S. financial system.

In its best known and most publicized feature, the Senate bill raises the asset size threshold that Dodd-Frank established for subjecting a bank to strict scrutiny (such as the imposition of stress tests, liquidity requirements, and resolution plans) from $50 billion to $250 billion. In this post, we examine the role of asset size in determining the systemic importance of a financial intermediary. It turns out that (aside from the very largest institutions, where it does in fact dominate) balance sheet size is not a terribly useful indicator of the vulnerability a bank creates. We conclude that Congress should ease the strict oversight burden on institutions that pose little threat to the financial system without raising the Dodd-Frank threshold dramatically.

Judge makes an elegant proposal for accomplishing this. For institutions with assets between $100 billion and $250 billion, Congress should just flip the default. Rather than obliging the Fed to prove a mid-sized bank’s riskiness, give the bank the opportunity to prove it is safe. This approach gives institutions the incentive to limit the systemic risk they create in ways that they can verify. It also sharply reduces the risk of litigation by banks that the Fed deems risky...

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