UK banks are too big

By Felix Salmon
June 18, 2009

Peter Thal Larsen picks up on a potentially-explosive quote from Bank of England governor Mervyn King last night: that “if some banks are thought to be too big to fail, then, in the words of a distinguished American economist, they are too big”. King, of course, is the UK’s top bank regulator, which means that some of the biggest banks in the world ought to be feeling rather worried right now: too-big-to-fail banks dominate the UK banking system.

King does in his subsequent thoughts back off a little from the implication that TBTF banks should simply be chopped up into small-enough-to-fail pieces. Instead, he seems to think that something along the lines of Glass-Steagall might be in order:

It is not sensible to allow large banks to combine high street retail banking with risky investment banking or funding strategies, and then provide an implicit state guarantee against failure.

I think this doesn’t go far enough: both high street retail banks and risky investment banks can be TBTF, and blowups can happen in retail banks as well as investment banks. Just look at Northern Rock.

My bright idea is a simple cap on the size of any bank’s balance sheet: I’ve proposed $300 billion in the US, and the number would presumably be smaller in the UK. That’s a lot easier than trying to create highly-complex capital adequacy standards which fluctuate according to perceived systemic risk. And a lot harder to game.

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7 comments so far

if banks are small enough to fail who is going to pay the bills when they do fail?

Big, small, bigger, smaller: it all comes down to managing capital and managing risk. Any doofus can open a bank with enough capital and the proper charter documentation. I am certain that Jamie Dimon, for one example, might argue that mis-management at any size institution is crippling for all involved (shareholders, employees, depositors, borrowers).

Id think $500 billion is a good cap amount. Should also be focused on market deposit share %%…which I think is 10% on a national basis (and only BAC nears that mark, or may even eclipse it).

Posted by Griff | Report as abusive

I think arbitary caps on the size of a banks balance sheet completly miss the point, yes you want some externally verifiable measure for testing if a bank is too big to fail.

At the end of the day the regulators should pay closer attention to the banks risk departments and to the activities they engage in. Yes TBTF is an issue but a smaller bank can have systemic consequences, Northen Rock is again a good example here.

Also one of the benifits of the single currnency in europe was to encourage cross border transactions, there are benifits to the consumer and the bank of having a presense in more than one country. A fact I think many Americans miss, indeed one I am suprised Mr Salmon makes given his European background.

Posted by Chris Allison | Report as abusive

I think it is more important to change incentives. Paying executives and major traders in a portfolio of stock, preferred stock, and bonds representing the firm’s entire capital structure, and then requiring them to hold those assets over the medium- to long-term, is the simplest and likely most effective solution. It would make them much more sensitive to risk and give them an incentive to bring failing firms in for a soft landing. Strategies that increase risk more than it increases return will reduce the value of their bond holdings more than it increase the value of their stocks. More than the firm having “skin in the game” it is important that executives do.

Posted by DCreader | Report as abusive

You’ve misread him slightly I think – he goes as far as you want him to, and a bit further. Merv is bothered about *three* things:

a) combining retail banking and “risky investment banking” – like BarCap/Barclays, say, or RBS.

b) the rise of retail banks that had “risky funding strategies” (Northern Rock, or – actually a far, far bigger problem – HBOS). You seem to think Merv’s missed this one, but he hasn’t.

c) the implicit government guarantee, which first creates a huge moral hazard, then leaves a whole mass of detailed implementation decisions to be made when the balloon goes up, and finally leaves the taxpayer on the hook for the new capital needed. Merv has just lived through all that. If I were him I would now want the guarantee scoped and the implementation plan for next time worked out in advance, with a legal framework that mitigates the moral hazard.

A UK version of Glass-Steagall would only address the first of Merv’s problems. You would need a UK FDIC to address problem (c). In fact FDIC, the institution, and Glass-Steagall, the law, used to complement each other nicely in the States. Joined-up thinking back in the 30s. Sadly the less joined-up thinkers of more recent times left FDIC flapping in the breeze somewhat when they repealed Glass-Steagall – or earlier, when Citgroup was allowed to turn itself into a monster. Perhaps repealing Glass-Steagall was like opening the stable door after the horse had bolted right though it.

To address problem (b) you need something different. The question is: what is the best way to manage the risk that banks wake up one day to find that the funds they raise from securitization markets suddenly aren’t there any more? Sounds like a job for a lender of last resort to me. Merv knows where to find one of those, I suspect.

Posted by Richard Smith | Report as abusive


Bondholders, perhaps? And in any case smaller failures mean smaller costs – I’d wager the damage relative to the size of a bank failure is not linear.

Posted by ab | Report as abusive

I would limit the amount of risk-based capital that they could employ, and make sure that the actual tangible capital was twice that. Use a scheme like the insurers use. It works well for us — few defaults since it was instituted.

Oh, and the insurance regulators don’t allow for soft types of capital…

PS — Okay, AIG was an exception, but they hid what they were doing with securities lending… a hole in the formula, I think. Had most of the life insurance subs been independent, most would have failed. Also the mortgage insurance subs, but for different reasons…

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