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May 1997

The Competitive Implications of Safety Net-Related Subsidies (WP 97-9)

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Collection: Economics Working Papers Archive


Some people favor maintaining constraints on bank powers and organizational form because they believe banks receive a significant net subsidy from access to the federal safety net. They argue that this net subsidy will be successfully transferred to subsidiaries or affiliates engaged in non-traditional activities, giving these units a significant competitive advantage vis-a-vis rivals not affiliated with insured depository institutions. A variant of this view is the belief that a holding company structure is more likely to impede the transmission of the subsidy than is a bank subsidiary structure.

While it is difficult to draw firm general conclusions about the size of the subsidy from available studies, the weight of the evidence suggests that most banks have not enjoyed a large gross subsidy in the past. Typically, researchers find small gross subsidy values for the vast majority of the banks in their samples. In fact, the estimated fair insurance values of most sample banks are below their respective explicit insurance premiums. Most studies do not estimate net subsidies because reliable measures of the regulatory costs borne by banks are not available. The rough cost estimates that do exist, however, are substantial. This implies that the size of any net deposit insurance-related subsidy enjoyed by most banks must be smaller than the low gross subsidy estimates reported in previous empirical work. Further, a number of supervisory actions taken in the late 80s and early 90s are likely to have reduced the size of any subsidy. These actions include higher minimum capital requirements, risk-based capital requirements, prompt corrective action, and a system of risk-based deposit insurance premiums.

Recent (June 1996) estimates suggest that the gross subsidies enjoyed by the largest banking companies in the United States are presently small and net subsidies are likely to be negative. Even if these numbers are underestimates, there is evidence that mechanisms like Section 23A and 23B restrictions on inter-company transactions and corporate separateness requirements can effectively impede the transmission of any safety net-related subsidy to noninsured subsidiaries or affiliates. Since the same two sets of insulating devices are used in both sorts of structures, there is no a priori reason or hard evidence to believe that transmission of the subsidy is more likely in one case or the other. There is some market evidence that subsidies are not substantial. When banks have an option, they do not uniformly locate activities within the bank or direct bank subsidiary where it is allegedly easier to take advantage any safety net-related subsidy. Banking organizations also do not systematically dominate activities (e.g., bank-eligible securities) where they can conduct the operations within the bank.


Gary Whalen

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