Debates over bank size have resurfaced in light of recent regional banking crises. Some of the constraints that smaller banks are facing, like deposit withdrawals and excessive concentrations in commercial real estate lending, have not affected larger banks as much.

This shows that expanding banks could be a step toward stability, despite the fact that detractors would argue that doing so would force taxpayers to shoulder the cost of bailing out additional “too big to fail” goliaths or would concentrate banking in a way that would harm consumers.

An additional issue is that expanding smaller and medium-sized banks is necessary to get to larger banks. And it’s becoming clear that there is some risk involved in this process.

Some of the problems at New York Community Bancorp, which announced a new chief executive and postponed its 2023 results report this week, are associated with the company’s growing size. This year, the share price of the company has dropped by about 70%.

Key traits of the banks that were at the center of the crisis last year, which was triggered by the failure of Silicon Valley Bank, are not shared by NYCB. These traits include a reliance on uninsured deposits, which makes them more hesitant, and enormous potential losses on bonds. In the third quarter of last year, NYCB reported having no “held-to-maturity” securities in its portfolio. In an update released early in February, the bank stated that about three-quarters of its deposits were collateralized or insured.
Visual: WSJ See Entire Picture
Visual: WSJ

However, it has recently increased the size of its assets, and as a result, its regulatory position has changed. As of its most recent report, NYCB’s assets had increased from $90 billion at the end of 2022 to over $110 billion. It acquired a portion of the Federal Deposit Insurance Corp.’s confiscated Signature Bank’s assets and liabilities last year.

Due to its expansion, it surpassed the regulatory requirement to become a Category IV banking institution. It finished acquiring Flagstar Bancorp towards the end of 2022, increasing its total assets from $63 billion in the third quarter of that year to $90 billion at the end of 2022.

NYCB reported in January of 2023 that it was more in line with “relevant bank peers, including Category IV banks” following a spike in loan-loss reserve levels in the fourth quarter of 2023. The bank added that it would “accelerate the building of capital to support our balance sheet as a Category IV bank” as a result of the dividend reduction it announced in January.

The Federal Reserve administers stress tests to large banks to gauge their reaction to shocks to the economy. They typically apply to Category IV banks every two years. For instance, the most recent stress test scenario projects a 40% drop in the price of commercial real estate. A bank may therefore be required to maintain higher capital requirements based on how it would fare in that and other risk scenarios.

Additionally, NYCB disclosed last week that “management discovered significant shortcomings in the business’s internal loan review procedures, resulting from inadequate supervision, risk assessment, and monitoring efforts.” New executives in charge of risk and audits have been named. Earlier this year, the bank said that it would be subject to stricter “requirements for overall risk management” because it was a Category IV bank.

NYCB Executive Chairman and Chief Executive Alessandro DiNello stated in a statement last week that “as we continue our transformation into a larger, more diversified commercial bank, it is imperative that we strengthen the company’s risk and compliance framework in order to drive the most value for our clients and shareholders.”

Rapid expansion was a neglected aspect of Silicon Valley Bank’s history. SVB Financial Group has around $70 billion in total assets at the end of 2019. The following year, it surged to $115 billion, and the year after that, it exceeded $200 billion. A spike in deposits, which increased from roughly $60 billion at the end of 2019 to over $170 billion right before its collapse, contributed to that.

Despite the extremely low rates at the time, it and many other banks poured money into government bonds because of the spike in deposits, which coincided with a pandemic era with poor lending demand.

Published in April of last year, a Federal Reserve assessment of SVB’s oversight and compliance stated that the bank’s “core risk-management capacity failed to keep up with rapid asset growth.” The bank’s expansion also altered the way it was overseen. As the company’s assets surpassed $100 billion, the study stated that oversight of the business was “complicated by the transition” from what is known as a Regional Banking Organization, or RBO, to a Large and Foreign Banking Organization, or LFBO.

So how could you avoid these issues and still have access to larger banks? Though current regulations also require regulatory methods to be “tailored” to a bank’s size, the Federal Reserve’s latest proposal for capital rules would extend some standards to a larger range of banks. Additionally, there can be a propensity for larger banks to acquire smaller ones. But that may bring up more difficult competition-related problems.

In the realm of banking, simple solutions are infrequent.