By Patrick Sims, psims@hamiltonps.com, 202-822-1205

When Senator Sherrod Brown (D-OH) discussed his new proposal to break up the largest U.S. banks and place a cap on future growth in a recent interview with Mike Konzecal of Washington Post’s Wonkblog, he misrepresented accounting standards to justify his idea to cap bank size. And the fact is, his overall proposal does little in the way of reducing systemic risk while placing the U.S. financial sector and the American taxpayer at a permanent disadvantage in the global economy. Below are a key counters to his main points.

Point #1: Smaller banks cannot provide the same services as larger banks

Point: “I have yet to hear why 20 super-regional banks couldn’t do a better job than 11 megabanks that benefit from implicit guarantees from the federal government.”

Counterpoint: It’s a misconception that smaller, regional banks would provide this service in the absence of large U.S. banks. If they could, they probably would. The syndicated loan market is a perfect example: In 2012, Wal-Mart received the largest syndicated loan of the year, valued at $11.8 billion. The loan required underwriting from six of the largest global banks, including the four largest U.S. banks and two British banks. For several other syndications of similar size, the same six banks, in addition to other foreign banks of similar size and services, provided the majority of financing.

Furthermore, not just loan syndications work this way, but all large-scale capital market activities do as well. Large foreign banks from Canada, Europe, Japan, and China will fill the gap. (Banking on Our Future: The Value of Big Banks in a Global Economy, Hamilton Place Strategies).

Point #2: Correct valuation of bank size reveals the largest U.S. bank ranks 4th in the world

Point: “U.S. megabanks are actually larger than they appear because the U.S. and Europe are on different accounting systems that change the way that derivatives exposures are calculated.”

Counterpoint: U.S. accounting standards (GAAP) allow an institution to show its derivative contracts on net rather than gross. This important element in the calculation of total assets prevents an institution from overvaluing its assets by overstating credit risk, obligations, and financial resources.

The International Swaps and Derivatives Association agrees with GAAP standards, as do the Federal Reserve, FDIC, OCC, and other regulators. According to regulators, “…offsetting criteria should be based on legal enforceability and the economic substance of an entity’s exposures to and from its counterparties.” If derivatives are not shown this way, it “… would impair rather than improve financial reporting by providing less relevant information to financial statement users.”

Therefore, it is more accurate to value international banks using U.S. GAAP standards, instead of the other way around. Based on this calculation, JPMorgan (the largest U.S. bank) ranks fourth largest in the world. Compared to home-country GDP, 24 foreign banks are significantly larger than JPMorgan.

Point #3: Arbitrary bank caps put the U.S. economy at a competitive disadvantage without addressing systemic risk.

Point: “Under my plan, the largest U.S. banks would have approximately $1.2 trillion in combined liabilities. The six biggest megabanks would be reduced from their current size of about 64 percent of U.S. GDP to about 34 percent of GDP, as they were in 2001.”

Counterpoint: Dodd-Frank better addresses systemic risk by offering a regulatory path to failure, thus ending bailouts for large firms, which did not exist pre-crisis. Recently, Fed Chairman Ben Bernanke, and Federal Reserve Governors Jay Powell and Bill Dudley each reiterated their support for recent changes and continued improvement. Break-up advocates are shy of admitting these details, but they are very real and help debunk popular myths.

Moreover, this arbitrary cap would place U.S. financial institutions at a competitive disadvantage to foreign firms and other sources of financing, whose size is increasing or already larger than the biggest U.S. banks, without addressing systemic risks.

This cap also is a boon for the shadow banking sector, which provides unique credit intermediation, largely unregulated. A run on the shadow sector was at the heart of the most recent crisis.

Now is not the time to retreat, but rather to reset, according to a recent McKinsey & Co. report. Supporting economic growth by completing regulatory reform initiatives and helping build more robust and sustainable capital markets is the smart choice. Senator Brown ignores these points. He’s right to want to protect taxpayers and shore up the financial system; however, his assumptions are flawed.

Patrick Sims is Director of Research at Hamilton Place Strategies. Prior to joining HPS, Patrick acted as the lead research analyst in the financial institutions’ group at SNL Financial and worked for the CFA Institute. He is a finance and international business graduate of James Madison University and studied EU Policy at the University of Salamanca, Spain.