Asset-based bank regulatory classifications are badly outdated

The size definitions used to classify banks are like a suit tailored in a different era. Over time, the financial body has changed — grown with inflation, reshaped by technology and stretched by competition — but we’ve failed to alter the suit. Today, we’re asking banks to operate under definitions that no longer fit, forcing many to choose between shrinking their ambitions or outgrowing their regulatory category, adding expense and complexity to their operations that may not fit the smaller businesses and other customers they want to serve.

It’s time to substantially revise the size thresholds that determine regulatory standards. If we do not, the banking industry will continue to wither in comparison to similarly sized nonbank competitors that have virtually no regulatory overhead. Or, as one bank executive recently shared with me, it’s either “acquire or be acquired.”

Regulatory burdens generally, and heightened standards in particular, have made banking so expensive that institutions must have a sizeable infrastructure operated by highly skilled talent to meet expectations. These expensive resources drive banks to grow in search of economies of scale.

Ironically, while the designation of “systemic” should serve as a deterrent due to its associated burdens, it often conveys an implied government safety net in the public’s mind, as seen during the spring 2023 bank failures when a “flight to safety” grew deposits at the megabanks at the expense of midsize and smaller institutions. And the regulatory community has done little to dispel this perception.

One compelling reason to update the size categories for our nation’s larger banking institutions is inflation. When these regulatory thresholds were established, many as a result of Dodd-Frank, they reflected a very different economic landscape. Since then, the value of the dollar has eroded significantly, with inflation reducing its purchasing power by nearly 50%. Yet the thresholds remain fixed. As a result, inflation has greatly changed the practical reality of which kinds of institutions fall into what categories.

The regulatory community also has modified its approach over time, often pressing banks to proactively build risk management and compliance systems appropriate for larger institutions in anticipation of their future growth. Whether or not this regulatory approach is sensible, it underscores the importance of updating size-based categories to reflect actual risk and on-the-ground capacity needs.

Furthermore, as more institutions chase systemic scale, the financial system becomes more concentrated and potentially more fragile. Encouraging a wider spectrum of sustainable bank sizes and models is not just a fairness issue — it’s a matter of systemic health. A recalibration of size-based classifications would allow a broader array of institutions to thrive without distorting incentives toward unchecked growth. By modernizing these thresholds, we can better support a diverse and resilient banking ecosystem that reflects both current economic conditions and future challenges.

This categorization problem does not just fall heavily on midsize institutions. First, the existing threshold under which an institution would be considered a “community bank” no longer reflects today’s economic landscape. For example, many urban community banks have grown commensurately with the growth of the cities they serve while maintaining a true community focus. Second, supervisory expectations have become far more process-driven and complex, giving rise to a need for larger teams across essentially all bank categories. Finally, all banks now face competition from much larger, less-regulated nonbank entities, placing added pressures on smaller banking organizations, which are asked to adopt much more expensive risk management and compliance infrastructures than before.

Beyond practical burdens, outdated size definitions also pose long-term risks to financial diversity and resilience. When regulatory design unintentionally incentivizes growth for its own sake, it pushes banks — ­ particularly smaller, regionally rooted institutions — toward homogenization. Banks that might otherwise specialize in local relationships or niche services are instead compelled to mirror larger peers in both structure and strategy. This pressure can erode the diversity of business models that makes the financial system more adaptive in times of stress. It also can diminish the incentives for smaller banks to continue to provide critical financial services to customers who would otherwise be underserved by the larger banking institutions.

Taken together, these realities point to the need to at least double the current size thresholds used for regulatory classification for our largest and smallest banks. To avoid this misalignment from recurring, future size categories should be indexed to inflation, with reasonable timing expectations for banking institutions to on- or off-ramp to the next category as their asset size changes. While some of these changes could be accomplished through rulemaking, others will require legislative action.