Big banks aren’t bad banks

By Mark Williams
February 2, 2010

— Mark T. Williams, a former Federal Reserve Bank examiner who teaches finance at Boston University School of Management, is the author of the soon to be published “Uncontrolled Risk” about the fall of Lehman Brothers. The views expressed are his own. –

Too big to fail has become nothing more than a political sound bite and the title of a best-selling book. Unfortunately, in the process big banks have gotten a bad rap. The proposed Obama administration plan to limit bank size is just another example of big-bank bashing by high-level politicians.

Policy that simply focuses on downsizing big banks overlooks an important point. The problem is not that banks are too big; it is that banks are taking excessive risk. This includes big and small banks. Since 2008, more than 170 banks have failed, including big banks such as Lehman Brothers, Wachovia, and IndyMac. But most on this list – such as Citizens State Bank, Republic Federal Bank, and First State Bank — are smallish. They didn’t make big headlines. No books were written about them or movies made.

The fact that a bank is big should not automatically mean they are a threat to the financial system. It’s true that Citigroup, once our nation’s biggest bank, needed a massive government bailout. But this singular sample size is not large enough on which to base far-reaching policy changes.

Big banks offer many advantages over smaller ones. They provide consumers with a greater array of desired services and economies of scale allow them to deliver more for less, and they tend to have greater capital to protect them against unexpected losses. In many countries in Europe and elsewhere, the universal banking system (another phrase for big banks) dominates the market. In these countries, a universal big-bank system works.

In Canada, the top five banks represent 90 percent of the market. During the Great Credit Crisis of 2008, not a single bank failed in Canada (nor did any fall during the Great Depression). A decade ago, no Canadian bank made the North American top-ten list. Today, four are Canadian. The lesson from our northern neighbors is simply that they had tighter lending standards, lower leverage ratios, and better regulatory oversight. They also taught us that slow and steady is a better risk strategy than fast and wobbly.

Using Canada as an example, the real concern should not be bank size but the level of risk taking. Banks make money only three ways — providing loans, proprietary trading, and/or charging fees for services. The main driver of the recent financial crisis was neither proprietary trading nor fee charges, but risky lending practices.

In theory, big banks armed with greater capital should have the ability to take on greater risk. They are also better positioned to compete globally. The problem comes when these banks do not have proper risk-management oversight and focus. The administration’s bank reform should stop obsessing on size and look at risk taking relative to capital position held.

Any meaningful financial reform should address lending standards while tightening regulatory oversight and policing. Proprietary trading, with the exception of Goldman Sachs, the thorn in Obama’s side, is a sideshow not the main show. Bank minimum capital levels should be increased. Any bank (big or small) that wants to engage in increased risk should be required to raise more capital. Leverage ratios should also be reduced.

In the end, it is not big or small that matters but the level of risk taking and the ability of banks and their regulators to adequately measure and control risk. A policy of simply bashing big banks will cost consumers and our nation’s competitive banking position. A country made up of ten well-capitalized big banks is much stronger than one with over 7,000 small banks taking dangerously big bets.

5 comments

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I do not agree with this analogy. Small banks and credit unions are not failing in droves. I also do not agree that ten big banks are better than 7000 small banks. This sounds like a book learner egghead analogy. Banking is a personal business between the banker and the customer and trust is built between them. I will not do my banking with bigger banks as they are faceless and nameless entities who hide behind 800 numbers. The biggest problem we have is too many pension plans have too much money to risk. When it goes bad they want all their money back. We need closer regulation, higher fees on profits, and a return to stabilization.

Posted by fred5407 | Report as abusive

“Reinstate Glass-Steagall”. After we see a firmer recovery (maybe). Oblame’ah unfortunately broke up a years worth of bipartisan work on regulatory reform with one “image boosting proposal” a surprise even to his own people! This new dynamic “world economy” is unlike the 1920′s, perhaps we need a solution tailored more towards today’s economy. Geithner Bernanke – represent Oblame’ah’s “resistance to change”

Posted by grr | Report as abusive

Too big to fail has become nothing more than a political sound bite and the title of a best-selling book.

You said it, Thank You.

China will be happy to take up the Slack and Jobs Oblame’ah, may put in jeopardy.

Posted by grr | Report as abusive

It is fashionable and politically expedient to beat up on the banks.

Where were the politicians during the housing bubble? They were demanding that the banks put unqualified Americans into home ownership! They pressured the banks to lend the money. It used to be that a contract was sacred. The borrower promised to pay back the debt. Now, the borrower just has to say, sorry, I don’t have it, so I get to keep the house anyway. Talk about moral hazards! We have whores for politicians. They take no responsibility. It’s too bad. The decline in personal responsibility in recent years has been astonishing.

Posted by pilgrimson | Report as abusive

Felix is close to spawning:

http://blogs.reuters.com/felix-salmon/20 10/02/03/the-volcker-rules-loopholes/

…EpicureanDeal, compared to this article by:

…”former Federal Reserve Bank examiner who teaches finance” – no wonder everything is screwed up.

Timmie and Bennie, leave the guys alone, they are dealing with fiscal and monetary drag from Bush,Cheney, Greenspan & Associates Inc.

Posted by Ghandiolfini | Report as abusive