Editor's opinion: Too big to fail?
Does "too big to fail" have any place in a market economy? The Governor of the Bank of England doesn't think so but cash management customers of the banks may feel differently.With bonuses back in vogue and regulators dithering on both sides of the pond as to whether they should split up the retail and investment divisions of the banks, the concept of "too big to fail", is proving a lot more difficult to put into practice than some may have originally thought.
Dodd-Frank provides for the "orderly liquidition" of a firm by regulators to avoid future taxpayer bailouts but given regulators' inconsistent approach to bailouts during the 2008 crisis with some banks being bailed out and others left to wither on the vine, some banks are still of the belief that they are too big to fail and wouldn't be wound down at the first sign of trouble.
Yet, while some of the large global banks may be thinking to themselves that they are too systemically important to be wound down by the regulators during a crisis, various studies by the UK's Centre for Economic Policy Research (CEPR) demonstrate that being "systemically important" or too big to fail is not all it is cracked up to be. One research paper published by the CEPR says "systemically important banks can increase their value by downsizing or splitting up, as they have become too big to save, potentially reversing the trend to ever larger banks" In another discussion paper it asserts that given a bank's interests costs increase in line with its "systemic size", its rate of return on assets tends to decrease the more systemically important they become.Shareholders in banks are unlikely to be happy about that.
Mervyn King, Governor of the Bank of England, also stepped into the debate at the weekend when he was quoted as saying,"We've not yet solved the 'too big to fail' or, as I prefer to call it, the 'too important to fail' problem. The concept of being too important to fail should have no place in a market economy." He said that "imbalances [were] beginning to grow again" and that unlike the manufacturing industry, which cared about its customers, banks had no sense of "longer-term relationships". "If it's possible [for financial services firms] to make money out of gullible or unsuspecting customers, particularly institutional customers, that is perfectly acceptable [to the banks]."
I am sure transaction banks would argue that relationships of trust are built up over time with their cash management customers, however, as the 2008 to 2009 crisis demonstrated, not all banks were prepared to stand by those relationships in customers' greatest time of need, and unlike consumers, it is not so easy for corporates to switch banking relationships at the drop of a hat if they are dissatisfied, unless of course they are using platforms like SWIFTNet, which enables them to more easily interact with multiple banking providers.
So should banks, no matter what their size, be allowed to fail? I am sure cash management customers of those so-called systemically important banks feel differently about this than the general public and Mervyn King. The only option is to make it easier for these customers to switch on and switch off banks so that if one fails they can quickly migrate their business to another. Is that really achievable though, or desirable?
Date Posted:5th March 2011