May 6, 2023

Two months ago, Silicon Valley Bank (SVB) failure increased uncertainty in financial markets. In contrast to the other seventy-two bank failures that have taken place in the United States since 2012, this one became big news because of the size of its assets and deposits ($319 billion and $264 billion), and it was ranked as the third biggest banking failure in the US Banking history.[1] Although the number of comments and opinions were huge,  it was hard to find convincing arguments explaining why size matters? Or even more important, under what circumstances size matters?

Economists have extensively explained the importance of the size of banks to analyse propagation effects during financial crisis, and how these effects impact on the real economy. As a consequence, central bankers have reinforced their banking regulation to reduce the probability of banking failures. Despite all these contributions, there are only few explanations about why banks’ size matters when the economy is not experiencing banking failures or is not going through a financial turmoil. In other words, under what circumstances size matters?

One potential explanation is the one given by Peter Paz Luque, who provides evidence that large banks, measured by the size of their equity, reduce their aggregate lending more than small banks after an increase in the interest rate takes place. Following Peter’s argument, whether an economy is populated with small or large banks is relevant to understand the dynamics of lending after a change in the cash rate.

Another potential explanation for why the size of banks matter is the one I show in a recent working paper (“Banking Heterogeneity, Credit Supply and Economic Growth”). Bank size matters to understand the dynamics in credit supply even when the economy is not experiencing a financial turmoil. As graph (a) shows, the top 10 percent and the bottom 10 percent of banks exhibit different average lending growth rates in the United States between 2009 and 2020. My evidence shows that small banks are more likely to experience a contraction in their credit supply, while medium or large banks tend to experience positive average lending rates.

[1]  Bank Failures Data was obtained from the US Federal Deposit Insurance Corporation (FDIC). Deposits data was obtained from the US Call Reports. 

Source: Call Report Data, United States

Notes: These graphs represent average lending growth rates for total, mortgage and business credit among the top 10 percent, the middle 80 percent and the bottom 10 percent of commercial banks in the United States from 2009 and 2019.  Although credit supply among banks is conditioned by market competition factors, average lending rates help to clarify how different banks expand and contract their lending. 

The analysis is even more informative when we consider real estate and business lending separately.  While average lending growth rates exhibit slightly similar dynamics between medium and large banks when we consider real estate loans, the same rates display different dynamics in the business credit channel.

Why is it important? Examining average lending growth rates among banks of different sizes helps to clarify the role of big and small banks in expansions and contractions of credit supply. Even more instructive is to think about how banks of different sizes, and with different market shares, play a role in the increasing or decreasing real estate and business loans.

“Why size matters?” is a question that policy makers and researchers should not only examine after banking failures. It is important to understand the different role of big and small banks in explaining lending dynamics. In other words, “Why size matters?” should encourage us to think about the connections between the banking sector and the macroeconomy. 

Juan Zurita is a PhD Candidate in Economics of the University of Technology Sydney (UTS), Australia, whose research examines the connections between the banking industry and the macroeconomy.