There have been a series of bizarre proposals to limit the size of banks in recent weeks, including from the governor of the Bank of England, various quarters in the US (although the preferred solution there is to allow the Federal Reserve to take on control of banks’ risk appetite as well as of interest rates*), and the government of Switzerland.
Put simply, the argument is that if a bank is “too big to fail” (i.e. the consequences of failure would be so great a government would have to bail the bank out to avoid it), it’s too big. That’s how the Bank of England governor Mervyn King puts it, anyhow.
It sounds nice.
And it’s also nonsense. Lehman Brothers was not considered too big to fail and thus was allowed to go under by US authorities. And, arguably, the collapse of Lehman Brothers was what took a banking problem, turned it into a full-on crisis, and precipitated a recession. Where would Lehman fit into Mervyn’s plans?
And what about the disproportionate power of big banks to lend at lower rates because of the amount of capital at their disposal and the ability that gives them to take bigger risks?
Not so long ago, that was seen as a good thing because it gave businesses access to money that they could transform into economic growth. Now, the very idea of a bank taking any risk is anathema. In which case, why not replace banks altogether? Perhaps with keeping money under an intercontinental mattress.
Refreshing, then, that someone with a healthy dose of common sense has noticed the solution too obvious for the Bank of England to see. The chairman of the Financial Services Authority, Lord Turner, has proposed that big banks simply hold more capital.
In basic terms, banks are in the business of taking in money and lending it out again. Which means that if everyone they’ve taken money from tries to get it back at once, the bank will fail because the bank will have lent out much (most) of that money and won’t have it to hand to give back. It also means that a bank that takes too much risk, lending to too many people who turn out not to repay their loans, will get itself into trouble because it won’t have enough money to give back when it’s supposed to.
What Lord Turner is proposing is that banks keep more money in a safe place and available to give back. If they did so, the risk inherent in banking would be lower.
In any other time, this would have been a no sh*t Sherlock point to make. That it escaped the attentions of Mervyn King, at least, is rather disturbing.
As for Switzerland, their failing bank du jour UBS is, indeed, rather big. Its balance sheet has been estimated at four times Switzerland’s annual GDP. So Switzerland might have a point.
But RBS, HBOS and British minnow Northern Rock are hardly in the same category.
* Quite how they intend to control banks’ risk levels remains something of a mystery.