Quantcast
Channel: theParetoCommons » global bank regulation
Viewing all articles
Browse latest Browse all 10

size, subsidiarization and stability

0
0

Once again very senior figures are proposing that the scale and structure of very large financial institutions be reconsidered. Nearly every major regulatory leader has raised the question, as have many economists across the political spectrum and in both the United States and United Kingdom. To explore, one can start here and here; I can assure you the list is very long indeed.

On Saturday Sir John Vickers, chairman of the British Independent Banking Commission and a very prominent economist, followed in the recent footsteps of Mervyn King, Governor of the Bank of England, to suggest that the scale on which global universal banks operate is a cause for concern and that they should be overhauled to make the financial system safer (full text here). Overhauling might, for example, involve restructuring these organizations so that they hold separately capitalized subsidiaries in different countries. (This is called “subsidiarization.”) Yesterday the British Deputy Prime Minister, Nicholas Clegg, expressed similar views during an interview on the BBC, though he would focus on reducing bank size or splitting them up by function (e.g., separating retail banking from investment banking–also a form of subsidiarization) rather than restructuring them. Similar concerns regarding the excessive size of financial institutions were expressed last week by the Bank of England’s head of financial stability, Andy Haldane. We should pay particular attention to the British because they were operating universal banks long before we were in the United States.

As with every previous attempt to address this issue, the largest universal banks are fighting back on every point. Jennifer Taub just just discussed their resistance to building up proper capital reserves and wanting to pay out more dividends. And the Financial Times reports on the views forcefully expressed once again last Friday by Mr Peter Sands, chief executive of Standard Chartered:

In his first interview on the issue – and one of the first lengthy public comments by a top British banker – Mr Sands bluntly rejects criticism of the universal banking model, which he says is widely recognised as being over­whelmingly positive in the fast-growing economies of Asia.

Enforced restructuring could be “very damaging” for the UK economy, especially the City of London, he says. And claims that subsidiarization would reduce the risk of a large banking failure were based on “a fundamental misunderstanding” of the financial stability provided by diversified earnings flows.

“We don’t think the arguments for structural separation of supposedly casino and utility banking stand up to scrutiny,” he says.

Mr Sands addresses a range of arguments. He asserts that requiring universal banks to be structured according to subsidiaries leads to balkanization and even greater risk to stability:

claims that subsidiarisation would reduce the risk of a large banking failure were based on “a fundamental misunderstanding” of the financial stability provided by diversified earnings flows.

Mr Sands also says that forced subsidiarization will lead to more regulatory arbitrage; he claims that moral hazard (ie excessive risk-taking because the knowledge that the bank would be bailed out if it got into trouble) did not contribute to the financial crisis; and he says that there is a lot of “muddled thinking” about the cross-funding support within these behemoths which, he says, is negated by transfer pricing.

Mr Sands does enjoy very distinguished support from Gene Ludwig, former Comptroller of the Currency who, in a recent op-ed in the American Banker argued that subsidiarization, which follows the structure of legal entities, is an inefficient kind of compartmentalization for universal banks because they run on lines of business that straddle various legal structures.

These are numerous, complicated issues to debate and there is lots of evidence to consider (much of which is being conveniently overlooked). Let me give the quick response:

1. There is still no serious evidence that these mega-combinations are more efficient than less complex ones. In fact the evidence is largely to the contrary. And there is plenty of evidence that if they fail the impact is very widespread indeed.

2. On diversified earnings flow, Mr Sands echoes almost the very words of Mr Ken Thompson, chief executive of Wachovia, as he was celebrating the acquisition of Golden West–the acquisition that destroyed the company!

3. Protesting the dangers of “regulatory arbitrage” sits rather uncomfortably with a bank executive: I never met one who would not prefer to avoid legal constraints if given the choice.

4. Subsidiarization, as Andy Haldane has indicated in a speech backed by an important study, is financial regulation’s way of trying to introduce the technique of modularity as a means of controlling for systemic risk in the event of an unexpected crisis. It is a perfectly legitimate consideration that should be objectively considered if we are to have any hope of containing disasters when one of these behemoths fails.

5. It is true that legal entities often do not match the structures preferred by those who run lines of business. Sometimes, indeed, they are excessively bureaucratic, inappropriate, or just plain outdated. But there are many reasons for legally-driven entity structures. They are there to incorporate public interest elements designed to compensate for the risks being undertaken, risks that otherwise get externalized onto the public. Until we have much more developed cross-border insolvency regimes they also make winding up (“resolving”) a global bank easier for individual countries. Legal structures might be inconvenient to business executives, but sometimes they are simply a cost of doing business in a way that is safer for the rest of us.

6. To claim that moral hazard is not created by the unavoidable safety net of too-big-to-fail policies is ludicrous. Tell that to the credit rating agencies who directly affect the pricing of bank debt in accordance with whether such banks are likely to be saved from failure by the government.

7. Transfer pricing (which is meant to price accurately the cost of internal funds transfers) does not work nearly so well in practice as Mr Sands would like to think, or at least have us believe, and it can facilitate major abuse. It is based on inconsistent models, some of which are arbitrary and some of which are never implemented properly. There is a reason that Citibank suffered from not having a strong retail deposit base in the United States, and it had nothing to do with wanting to price fully the cost of the funds it could have used from such a base.


Viewing all articles
Browse latest Browse all 10

Latest Images

Trending Articles





Latest Images