For the past few years, the media has created a misconception that large banks are bad. That characterization has led the general public and many investors to conclude that all large banks are unstable, dangerous, and bad investments. That characterization and conclusion are wrong. In fact, by international standards, the so-called megabanks are not actually all that huge.
Chinese banks are the real mega banks By total assets, JPMorgan Chaseis the largest bank in the U.S. Using the most current data available, it was, however, just the sixth-largest bank in the world.
Bank of America was ninth, and no other U.S. bank cracked the top 10.
Note: Data varies due to various reporting requirements abroad. Data is from between 12/31/2014 and 6/30/2015.
Citigroup was 13th,and Wells Fargo rounds out the U.S. megabank contingent in 14th place. The next largest U.S. bank is far down the list, in the 30thspot.
Hold on for one minute... you're focusing on the wrong thingMany people find it troublesome that the four largest banks in the world are all from China. Does that mean the U.S. has lost its global lead in finance?
Or if U.S. banks aren't really as big as the media makes them out to be, is "too big to fail" even a problem at all? If the largest domestic banks barely crack the top 20 globally, have we therefore eliminated the risk of another Wall Street-led financial crisis?
The problem with these conclusions and questions is that we're focusing on the wrong thing. A bank's size, large or small, doesn't necessarily make it risky.
Using a bank's size is too blunt of a tool. It doesn't give us the precise information we need to really understand the mechanics behind systemic risk, the state of the global financial system, or to properly assess any single institution.
Repeat after me: Size does not equal complexity There are all sorts of macroeconomic and political issues that define much of the large bank conversation. I'm not nearly smart enough or informed enough to help you with that part of the question. I can, however, help point you to a better way to think about this issue from an investing perspective.
Let's use an example. Wells Fargo is a megabank. It's huge. It's also a pretty simple operation. The bank makes loans, it accepts deposits, and it cross-sells other services like insurance and wealth management. That's about it. Nothing fancy to see here.
Then think about Goldman Sachs . Goldman is almost exactly half the size of Wells on a total-assets basis. However, Goldman is involved in investment banking, market making, high-frequency trading, derivatives, and a whole host of businesses far more complex than anything Wells is doing.
Wells is twice the size of Goldman, but its business model is simpler and much easier to understand. .The size of Wells Fargo's balance sheet has nothing to do with the risk profile. For investments in individual stocks, the complexity of the bank's business becomes a far more significant indicator of risk.
Risk can of course be mitigated; simpler banks will require simpler risk management programs while more complex institutions require more complex risk management. Either way, size isn't the driving factor.
The best financial minds in the world do it this way -- you should, too The smartest regulators in the world recognize that complexity is more significant than size at the global scale, and there's proof of it in how they designed the system to regulate the systemically important financial institutions, or SIFIs. Regulators decide if a bank is systemically important by assessing the impact on the economic system if a given bank collapsed. Size is a consideration, as it clearly must be to assess global impacts, but also concentration of assets, the bank's interconnections with the rest of the financial world, and any market, asset, or other concentrations.
Each institution determined to be systemically important is placed into a "bucket" -- yes, that is the technical term -- corresponding to that institution's risk to the global financial system. Bucket one holds the least risky SIFI banks, with each higher bucket representing more complexity, more interconnectedness, and a greater influence on the system.
Currently, there are no banks in the highest bucket, bucket five. This bucket was created as a deterrent to discourage banks from taking on the complexity and size that would be required to qualify. The regulatory requirements for a bucket five bank are, to put it lightly, tough. In this bucket a bank would be required to hold a significant level of extra capital, capital that could otherwise be invested elsewhere in the business to drive growth and profitability..
Of the U.S. banks, JPMorgan is in bucket four alongside the only other bucket-four bank, HSBC. Citigroup is one of four banks in bucket three. Bank of America, Goldman Sachs, and Morgan Stanleyare among the six banks in bucket two. Three U.S. banks, including Wells Fargo, are part of the 18 total banks in bucket one, the least risky of the SIFI designations.
What bucket is home to those giant, scary Chinese banks? Three of them sit beside Wells in bucket one. The China Construction Bank Corp. didn't even qualify as a SIFI institution.There are other, more prudential, considerations that play into this, as media reports have suggested that international bank regulators may have wanted to avoid putting undue pressure on China's banks out of fear that doing so would throttle global economic growth. However, the point remains: size alone does not necessarily equate to risk.
Big isn't necessarily bad When you're considering investing in any bank stock -- large or small -- do your best not to worry too much about the bank's size.This isn't to say that size is irrelevant -- there are regulatory implications that can impact expenses, capital, and even profitability -- but rather that a big bank isn't necessarily risky just like a small bank isn't necessarily safe.
Far more important from a risk standpoint is the complexity of a bank's operation. The riskiest banks are not the largest, but rather, they are the most complex. They're risky because there's no way to truly understand them, or predict how their business will react in future economic scenarios. None of those problems has anything to do with size.
The article U.S. Mega Banks Look Downright Tiny Compared to the Chinese Competition originally appeared on Fool.com.
Jay Jenkins has no position in any stocks mentioned. The Motley Fool owns and recommends Wells Fargo. The Motley Fool recommends Bank of America. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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