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Could big four banks’ profit party be spoiled without the too-big-to-fail bank subsidy?

An organisation called the Customer-Owned Banking Association, made up of credit unions and building societies, is demanding that the big four banks hold more capital to make up for the “too-big-to fail” subsidy advantage. The subsidy was quantified to be on average worth about $2.9 billion – $4.5 billion.

Together the big banks already control about 80% of the residential mortgage market. Commonwealth Bank of Australia (ASX: CBA) has the biggest market share for home loans, followed by Westpac Banking Corp (ASX: WBC), National Australia Bank Ltd. (ASX: NAB) and Australia and New Zealand Banking Group (ASX: ANZ) in that order.

As it is, taxpayer-backed government support to cover bank accounts should a big bank fail gives the big four banks an advantage over smaller banks and credit unions. This support helps them lower their cost of funding because they are seen as a better risk.

That translates into lower costs of funding by around 0.21% – 0.34%.

Either that could go toward increasing earnings or be applied towards lowering mortgage interest rates to attract borrowers.

In a competitive market with record low interest rates, that much of a difference could give the big banks a competitive advantage to match or even beat smaller lenders.

Small lenders have to fight and scratch to get a meaningful portion in the remainder of an already crowded end of the market. Even the fifth largest bank, Suncorp Group Ltd (ASX: SUN) would like to see the loan market playing field levelled. A sentiment also echoed by other regional banks.

For investors, the big four bank stocks are already seen as high priced after rising strongly over the past two years. They have had big profit gains recently and still offer attractive dividend yields. However, in a record low interest rate environment, their earnings margins may get squeezed.

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Motley Fool contributor Darryl Daté-Shappard does not own shares in any company mentioned.