The number of banks in the US had been increasing until the mid 1980s whereupon the number began declining again despite growing population and wealth. A few banks became extremely large: "too big to fail." Super large institutions suffer from more moral hazard and take on too much risk due to the implicit government guarantee. There are two options to avoid moral hazard. 1) we could prevent banks from getting too large to fail. The government regularly takes over ('nationalizes') small failing banks and liquidates them but huge banks would be much more difficult to do this with. 2) we could impose additional regulations upon big banks to prevent risky behavior. Canada has this kind of system and it has worked well for them so far.

Too Few Banks, Too Many Giants: I have repeatedly mentioned Too Big To Succeed as a cause of the most recent crisis, but have you ever wondered HOW we got that way?

One obvious suspect has been the easy M&A environment of the past 20 years. Instead of a very competitive market where mergers for sheer size sake is discouraged, the opposite occurred. The number of bank acquisitions skyrocketed, and the number actual banks got slashed. Where there were once over 18,000 banks in early 1980s, today, the number is less than half, to under 8,500.

Recall that the big acquisitions and mergers in the 1980s were so banks could be competitive with Sumitomo and Mitsubishi and other big Japanese banks. (Why was that again?)

Hence, we end up with a few Superbanks. Ask yourself why Citibank, Bank of America, Washington Mutual, and Wachovia got to be too large to manage. And once again, I am compelled to ask why it is in the country’s interest that 65% of the depository assets are held by only a handful of banks.

To put this into context, consider the chart below, courtesy of banking analyst Dick Bove:

chart courtesy of Rochdale Securities

(click on graph to enlarge)