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"Too big to fail" banks still have competitive edge

America's "too big to fail" banks still have an advantage over smaller lenders because of the perception the government will bail them out, but that edge has diminished since the 2008 financial crisis.

According to a new report by the Government Accountability Office, the nation's largest banks were able to borrow at a lower cost than smaller ones after the housing crash because investors believed they were too important to the U.S. financial system for the government to let them collapse. However, while large banks are still charged lower interest rates than smaller ones, the difference has declined from 1 percent to between 0.4 percent and 0.15 percent today, the agency found.

The GAO suggested that the subsidies accruing to big banks may have declined not because the banks are seen as less likely to receive bailouts, but because the overall credit environment is safer. The report also found this advantage could return during a financial crisis because regulatory reforms, including the Dodd-Frank Act, "have reduced but not eliminated the likelihood the federal government would prevent the failure of one of the largest bank holding companies."

"It is possible that we can see these type of advantages re-emerge," Lawrance Evans, the GAO's director of financial markets said in testimony on Thursday before Congress. "It will probably take another financial crisis to really see if the financial reforms were effective."

However, the GAO also found that the increased costs to the largest banks of these regulatory changes served to further reduce their advantage over smaller banks during normal economic times.

The GAO stops short of saying directly whether large banks retain a competitive advantage. Sens. Sherrod Brown, an Ohio Democrat, and David Vitter, a Louisiana Republican requested the report from the GAO. Brown said that Congress needs to take more action to protect the nation's financial system.

"Wall Street lobbyists may try to spin that the advantage has lessened," Sen. Brown said Thursday in a statement. "But if the Army Corps of Engineers came out with study that said a levee system works pretty well when it's sunny -- but couldn't be trusted in a hurricane -- we would take that as evidence we need to act."

Several senators have introduced legislation to impose tougher rules on the largest banks. Brown and Vitter want banks with more than $500 billion in assets to hold capital of at least 15 percent of their assets, more than double the current international Basel III standard. Sens. Elizabeth Warren, D-Mass., and John McCain, R-Ariz., have introduced a bill that would effectively create a new Glass-Steagall Act, the Depression-era law which separated commercial and investment banking that was largely repealed in 1999.

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    Constantine von Hoffman is a freelance writer and writing coach. His work has appeared in outlets such as Harvard Business Review, NPR, Sierra magazine, Brandweek, CIO, The Boston Herald, TheStreet.com, CSO, and Boston Magazine.