How Our Big Banks Really Make Their Money

(Originally published here.)

The eight biggest U.S. banks earned more than $80 billion last year, with much of that coming from government subsidies, according to a new report from the International Monetary Fund. Worst of all, the Dodd-Frank reforms and Basel III regulations haven’t done much to reduce these subsidies.

Banks make money by borrowing at lower interest rates than they earn on their loans and other assets. Banks’ borrowing costs are lower than they might be otherwise because their debt is guaranteed by the government. Deposit insurance is an explicit form of government protection, and banks pay for it.

But the biggest and most interconnected banks also benefit from a less tangible subsidy because they are believed to be too important to fail — if a big bank is on the verge of collapse and can’t repay its creditors, taxpayers will be asked to make up the difference to avoid a broader crisis.

The chart below compares the actual profits of the eight so-called systemically important U.S. banks against the IMF’s estimated annual value of their subsidies.

Using the lowest estimates, the big banks can attribute almost a fourth of last year’s profits to taxpayer largess. Higher estimates suggest that almost all of the big banks’ earnings in 2013 were due to subsidies rather than productive activity. The IMF notes that even “these dollar values likely underestimate the true TITF subsidy values” because, among other things, the calculations are based on the assumption that shareholders in bailed-out banks would lose everything, which isn’t usually what happens.

The range of estimates is wide because there is no single way to measure the size of the hidden transfers to the big banks, so the IMF used multiple measures. (Here are a few other recent approaches, all of which show that a subsidy exists, and those interested in the IMF’s methodologies should be sure to read the annexes at the back of the report.)

No matter how you count it, U.S. taxpayers continue to transfer tens of billions of dollars each year to the big banks.

To contact the writer of this article: Matthew C. Klein at mklein62@bloomberg.net.

To contact the editor responsible for this article: James Greiff at jgreiff@bloomberg.net.

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About Matthew C. Klein

I write about the economy and financial markets for Bloomberg View. Before that I wrote for The Economist on a fellowship provided by the Marjorie Deane Financial Journalism Foundation. I have worked at the world's largest hedge fund and read every FOMC transcript since May, 1987.
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