In a recent article, the Fed reached a striking conclusion: post-GFC prudential reforms aimed at large banks have not reduced solvency risk. In fact, deposit-funding risk at large banks has increased. Because the paper has received little mainstream coverage, many may have missed it. We highlight it here because it challenges the prevailing narrative that “large banks are well capitalized and far better prepared for a crisis than before the GFC”- and it does so using the Fed’s own analysis.
The article introduces a new, more forward-looking solvency metric – economic capital – that is timelier and more comprehensive than many commonly used measures. Rather than focusing on accounting capital, the Fed estimates economic capital, which makes more sense from a risk management standpoint.
In recent years, accounting changes have made it easier for large banks to obscure their true financial condition. For example, we recently discussed a rule change that may let large institutions mask troubled loans and early signs of portfolio stress.
Under their definition of “economic capital,” the Fed incorporates:
- changes in bank value from interest-rate and credit-
spread movements, - losses captured in traditional solvency measures, and
- assumptions about payment timing and deposit stability.
The Fed now calculates EC for banks back to 1997.
The findings will surprise anyone who has listened to bank CEOs and regulators assert for the past decade that large banks are better prepared for a crisis than before the GFC – often crediting carefully designed post-crisis reforms.
As the chart below indicates, post-crisis prudential changes for larger banks do not appear to have produced materially lower solvency risk, either over time or relative to smaller banks.
Source: Fed
Note: The chart shows economic capital scaled by assets from 1997:Q2 to 2025:Q1 for all commercial banks with assets exceeding $50 million, excluding trust banks. The blue diamonds are average values, the red diamonds are asset-weighted averages, and the grey shading depicts the 5th to 95th percentile range. The dashed line is the average yield on B- and BB-rated corporate bonds.
The red diamonds (asset-weighted averages, i.e., large banks) show that large-bank economic capital has not improved relative to pre-GFC levels; it has actually declined over roughly the past five years.
In addition, deposit-funding risk at larger banks has risen significantly as these firms have increased their reliance on uninsured deposits.
Source: Fed
As such, on a forward-looking, more accurate, and more comprehensive measure like economic capital, large banks are not better capitalized than before the GFC, and they also face higher deposit-funding risk.
But what about the asset side? In 2008, the primary fault line was residential mortgages. Today, the vulnerabilities are broader. Post-GFC underwriting and regulatory reforms strengthened mortgage quality, making residential mortgages the best-performing major credit segment in the US by asset quality. At the same time, standards in other areas have loosened.
As a result, banks now face a wider set of risks, including the CRE refinancing wall, rising stress in credit cards and auto lending, underwater long-duration securities and derivatives exposures, elevated C&I default risk, and fragilities in shadow banking.
In short, large banks’ combined capital positions are no stronger than pre-GFC and with a worse asset mix, showing notable stress even in a still-relatively benign macroeconomic environment.
Management incentives help explain how we got into this situation. There is a clear conflict of interest between banks’ senior management and the banks’ counterparties who care about financial stability -especially retail depositors. Bonus payouts are typically tied to return on equity (ROE). Lower ROE means lower bonuses, which are often far larger than base salaries.
ROE is important, but other metrics matter more in a crisis. (For your information and in comparison, we use 20 metrics to evaluate a bank’s health.) Yet senior-management goals often diverge from depositors’ interests.
Compounding this, there is no personal liability for bank failure. Riskier activities can boost ROE in expansions and bull markets – so management collects bonuses. If a bank fails, the worst case is usually job loss. Only regulators can curb excessive risk-taking, and they clearly have chosen a more hands-off approach.
Many still rely on deposit-insurance schemes without recognizing their design limits. Modern depositor-protection programs globally were built for idiosyncratic failures, not systemic crises. The FDIC fund totals about $145B versus roughly $1.5T in insured US deposits – less than 1.5% coverage – clearly not sized for a large crisis.
Recent academic work also finds that deposit insurance can weaken market discipline: if depositors stop monitoring the banks that hold their cash, banks are encouraged to take on excessive risk. Given the current capital and asset quality at large banks, that research looks prescient.
Over the past six months, the Fed has published multiple pieces highlighting major banking-system risks – often in sharp contrast to what bank CEOs are saying. We’ve seen analyses on potential deposit runs tied to the CRE refinancing wall, very high bad-loan ratios in student loans, growing stress in credit cards and auto lending, and now this work on economic capital at large banks.
We wouldn’t rule out that the Fed is laying the groundwork to later say it warned retail depositors, placing the onus on them for not finding a safer bank.
The question is whether you are paying attention?
Bottom Line
Believe it or not, there are more major issues on the larger bank balance sheets as compared to smaller banks, which we have covered in past articles. Moreover, consider that there was one major issue that caused the GFC back in 2008, whereas today, we currently have many more large issues on bank balance sheets.
These risk factors include major issues in commercial real estate, rising risks in consumer debt (approaching 2007 levels), underwater long-term securities, over-the-counter derivatives, high-risk shadow banking (the lending for which has exploded), and elevated default risk in commercial and industrial (C&I) lending. So, in our opinion, the current banking environment presents even greater risks than what we have seen during the 2008 GFC.
Almost all the banks that we have recommended to our clients are community banks, which do not have any of the issues we have been outlining over the last several years. Of course, we’re not saying that all community banks are good. There are a lot of small community banks that are much weaker than larger banks.
That’s why it’s absolutely imperative to engage in a thorough due diligence to find a safer bank for your hard-earned money. And what we have found is that there are still some very solid and safe community banks with conservative business models.
So, I want to take this opportunity to remind you that we have reviewed many larger banks in our public articles. But I must warn you: The substance of that analysis is not looking too good for the future of the larger banks in the United States, and you can read about them in the prior articles we have written.
Moreover, if you believe that the banking issues have been addressed, I think that New York Community Bank is reminding us that we have likely only seen the tip of the iceberg. We were also able to identify the exact reasons in a public article that caused SVB to fail. And I can assure you that they have not been resolved. It’s now only a matter of time before the rest of the market begins to take notice. By then, it will likely be too late for many bank deposit holders.
At the end of the day, we’re speaking of protecting your hard-earned money. Therefore, it behooves you to engage in due diligence regarding the banks that currently house your money.
You have a responsibility to yourself and your family to make sure your money resides in only the safest of institutions. And if you’re relying on the FDIC, I suggest you read our prior articles, which outline why such reliance will not be as prudent as you may believe in the coming years, with one of the main reasons being the banking industry’s desired move towards bail-ins. (And, if you do not know what a bail-in is, I suggest you read our prior articles.)