Richard Fisher has once again sounded a familiar clarion call: "Too big to fail” cannot be a principle the US financial system continues to abide by.
Speaking at the National Press Club in Washington on Wednesday, the Federal Reserve Bank of Dallas President said the Dodd-Frank legislation had done little to alleviate several of the issues that confront the financial system. He went on to add that if anything, the law had made things even worse.
The current scheme of things is such that in the absence of a bailout we would be faced with the collapse of the financial system as we know it. He went on to emphasize the need to split banking behemoths into smaller units.
Bank concentration has increased significantly over the years, particularly from 1970 to 2010. But what is of particular interest is how sector concentration has changed after the financial crisis. According to data from the Federal Reserve Bank of Dallas, the leading 100 banks in the US had an 84% market share. By the third quarter of 2012, concentration had increased further. The top 82 banks now had an 88% market share. Given this situation, if another banking crisis occurs, the impact would be clearly larger.
Further, Dallas Fed data also shows that Lehman Brothers, which had to face bankruptcy following the crisis, was a small player compared to JPMorgan Chase & Co. (JPM - Free Report) , Bank of America Corporation (BAC - Free Report) , The Goldman Sachs Group, Inc. (GS - Free Report) , Citigroup, Inc. (C - Free Report) and Morgan Stanley (MS - Free Report) . This conclusion is based on an analysis of non-deposit liabilities, subsidiaries and number of countries of operation. In fact, Lehman didn’t even figure in the top ten.
Fisher’s call to split up the megabanks seems to have found support in the actions of Germany’s financial markets regulator. The regulator has asked Deutsche Bank to undertake a simulation exercise which would examine a scenario where it splits up its securities and retail business.
However, this proposal, named after Erkki Liikanen, Governor of the Bank of Finland, would go on to raise costs for clients, says Deutsche Bank AG (DB - Free Report) co-CEO Anshu Jain. Therefore, he says, it should only be implemented if all banks worldwide have no choice but to comply with such regulations.
Speaking at a panel discussion in Koenigstein, near Frankfurt, Jain and JPMorgan’s CEO Jamie Dimon said banks and regulators should work on creating a system where in the event of a crisis, large banks can close down without damage to the public. These closures should also happen without the costs associated with the large bailouts which occurred after 2008’s financial crisis.
Dimon added that banks as large as JPMorgan can be shut down without harming taxpayers. But such a process would require regulators across countries to work together closely because of the global nature of these bank’s operations. He also said new capital and liquidity requirements collectively known as Basel III will further strengthen the banking system.
Fisher wishes to address the situation by clearly defining where safety nets for the banking system should end. He argues that only commercial banks would have access to deposit insurance provided by the Federal Deposit Insurance Corporation (FDIC) and discount window loans provided by the Federal Reserve.
This would in turn be reinforced by a new disclosure statement that declares the unprotected status of participants not protected by the safety net. This includes customers, creditors and other interested parties.
Jain and Dimon still argue against splitting up larger banks. Clearly, they offer a wide basket of services which greatly benefit the economy. They also continuously point to the greater costs this would entail to clients. Splitting up a megabank, therefore, may not be the magic wand for the financial system’s problems. Strengthening the regulatory framework and ensuring more effective implementation may be a more practicable solution.