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Fed’s Tarullo advocates cap to reduce size of American banks

Daniel Tarullo

Governor Daniel Tarullo of the Federal Reserve advocated a measure last week that would limit the size of banks by capping their non-deposit liabilities at a certain percentage of the nation’s gross domestic product.

Tarullo’s statement comes at a time of fierce debate over the 2010 Dodd-Frank Act, which has been criticized as being too complex and protective of “too-big-to-fail” institutions.

Simon Johnson, a professor at the Massachusetts Institute of Technology who has advocated limiting the size of banks, said that Tarullo’s statements “mark a significant—perhaps even dramatic—shift in thinking at the central bank,” DealBook reports.

Tarullo’s proposal would focus on limiting non-deposit liabilities, or borrowing by banks to finance themselves that excludes deposits. Legislation would be required to establish the percentage at which non-deposit liabilities would be capped.

At the end of June, JPMorgan Chase had $1.24 trillion of non-deposit liabilities, which represents eight percent of America’s GDP. If legislation capped non-deposit liabilities at five percent, Chase would be required to rid itself of the excess borrowings, which would essentially reduce the bank’s size, according to DealBook.

Sen. Sherrod Brown (D-Ohio) introduced a bill earlier this year that would establish the cap at two percent of GDP, though the bill has not progressed since. The cap would force the largest U.S. banks, including Bank of America, Citigroup and Goldman Sachs, to reduce their size.

Other suggestions include a cap establishing a GDP percentage that would allow banks to maintain their current size but limit any future growth, DealBook reports.

Some critics of the cap maintain that it could discourage banks from issuing long-term debt, which can be a solid financing source during economic crises, while others say that efforts to limit the size of banks could be detrimental to the economy, as both large and small banks are necessary.

Michael S. Barr, a professor at the University of Michigan Law School and former assistant secretary to the U.S. Treasury, said that the numerous financial control mechanisms of Dodd-Frank would be more effective as opposed to one financial tool.

“I think it’s a mistake to think there’s some sort of silver bullet here,” Barr said, adding that eliminating portions of Dodd-Frank would be a mistake, according to DealBook. “If Congress took up reform, it would only be in the direction of weakening [Dodd-Frank], not strengthening it.”

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