"'Too Big To Fail' was a major source of the crisis and we will not have successfully responded to the crisis if we do not address that successfully," Bernanke told reporters. Bernanke was acknowledging what many big bank critics including Massachusetts Senator Elizabeth Warren have been arguing -- that the market still expects big banks to be rescued in a crisis, even though new rules under the Dodd Frank Act are designed to prevent future bailouts. The market's perception, however misplaced, gives big banks a funding advantage over smaller banks in the market. A Bloomberg study estimated this implicit market subsidy to be over $80 billion, though some in the financial industry have disputed that number. The perception that banks are too big to fail also may provide banks with an incentive to take on more risk.
Stirring up even more controversy, Attorney General Eric Holder recently said that the size of some financial institutions and their impact on the economy weighed on the Department of Justice's ability to successfully prosecute them. In effect big banks were now "Too Big to Jail." That has led to more calls to break up the big banks from both sides of the political aisle. Ohio Democrat Senator Sherrod Brown and Louisiana Republican Senator David Vitter are crafting legislation that would cap the size of big banks.
Indeed, in Congressional testimony last year, Bernanke said that post-crisis regulations requiring large banks to hold higher capital and subject them to a greater supervision would "take away the advantage of size." "Market forces themselves will make it attractive to downsize, rationalize and so on," said Bernanke. Bank stock performance has improved over the past year on the back of the housing recovery, but big banks are no longer able to deliver the returns on equity they once did. Regulators have raised capital standards and dictate what they can or cannot do with their capital. Big banks have been effectively banned from considering further acquisitions. They also need the Fed's approval to raise dividends and buy back shares, and the regulator has been tightfisted in handing out approvals for big capital deployment plans. Late last year, a group of shareholders called for the breakup of Citigroup ( C), as its stock constantly traded below book value. The SEC has allowed Citigroup to block the shareholder vote on the potential breakup. But shareholders' demand for better returns have forced Citigroup to shrink. The bank has in the last few months embarked on a massive restructuring operation to boost returns to shareholders. Citi is in the midst of slashing 11,000 jobs, closing branches and plans to exit several unprofitable markets that fail to deliver on targets.. Other banks are also set to get smaller. Bank of America ( BAC) has been selling off non-core assets for the last few years and continues to reduce its balance sheet.
Banks have been reconfiguring their trading and capital markets businesses in anticipation of the Volcker rule, which prohibits proprietary trading and reins in risk-taking activities. They are far from through with their restructuring efforts. "In the next 12-18 months there is going to be a lot of internal pressure at banks. Management is going to have to evaluate what are core parts and what is really superfluous," says Gardner. "It is already happening. It is just happening slowly so you can't see it." -- Written by Shanthi Bharatwaj in New York.