Ackermann makes half-baked case for reform

July 30, 2009

In the debate about the future of financial regulation, most senior bank executives have been notable by their silence, preferring to lobby behind the scenes rather than argue their case in public.


So we should welcome Josef Ackermann’s effort to publicly put the case for big banks. In a long screed published in today’s FT, the chief executive of Deutsche Bank makes the argument that cross-border financial institutions are important for the success of the global economy, and that cutting them back to size would be a mistake.


It would be easy to dismiss Ackermann’s views as self-serving. After all, he runs a global investment bank that has much to lose from increased regulation, and is chairman of the Institute for International Finance, the talking shop for big banks. 


His argument is thoughtful and deserves a more measured response. Nevertheless it has a couple of significant flaws.


Ackermann’s case can be boiled down to two points. First, there is no need to break up big banks in order to make the system safer. Second, doing so would impose costs on the economy that would reduce growth and undermine prosperity.


He is far from persuasive on both counts.


Take the case of bank size. Ackermann rightly points out that small banks are not necessarily safer. Even relatively small institutions such as Lehman Brothers and Hypo Real Estate can pose systemic risks. Instead, he sees the answer in greater cross-border regulation.


Consequently, we should not seek answers in the perceived safety of nation-based structures, but rather establish effective processes for cross-border crisis management. It is not the existence of global financial institutions that creates unnecessary economic costs for our societies in a crisis situation, but the lack of internationally co-ordinated crisis management.


Ackermann has some useful suggestions for limiting the impact of bank failures. He endorses central counterparties for markets such as derivatives, and proposes that systemically vital functions such as payment systems be protected from the failure of the parent institution (though I have no idea how that would actually work).


However, he fails to address the central lesson of the financial crisis, which is that taxpayers are the ultimate guarantors of the financial system. If national governments are solely responsible for rescuing banks that happen to be headquartered in their country, then it is inevitable that they will seek to limit those costs.


The alternative is some kind of agreement between countries about sharing the burdens of a future financial collapse, possibly by devolving power to a supra-national regulator. But this is a pipe-dream, even in the European Union. Which may explain why Ackermann does not even venture to suggest it.


And if the alternative is a more fragmented financial system, where large banks become holding companies for a series of separately capitalised national subsidiaries, what are the costs? Ackermann believes they are large:


As evidenced in the period prior to the outbreak of the crisis, market integration can harness the world’s financial resources to fight poverty and raise growth rates, while it also allows for a quicker transfer of financial expertise as well as for asset and risk diversification.


In fact, this is far from clear. Do we really need global financial institutions in order for the global economy to work? And if we do, how can we judge the benefits of the boom without counting the costs of the bust?


Ackermann is right that reducing the size of banks will not, in itself, solve the problem. Higher capital and liquidity requirements will reduce the chances of a similar crisis happening again. Preparing banks for failure, and insulating their most systemically important functions, would limit the impact of future failures on the broader economy.


However, any discussion about the global financial system must begin and end with the distribution of the costs of a bank failure. Ackermann is suggesting that a system of nationally regulated and capitalised banks will limit future economic expansion. Perhaps he is right. The real question, however, is whether we can afford any of the alternatives.


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