Big is bad. At least that has become the view of many individuals about big banks ever since the financial crisis of 2007-2009. The fear is that if a big bank gets into trouble, its problems will infect other financial institutions and threaten the entire economy, and this fear prompted bank bailouts, both in the U.S. and abroad. In the wake of that experience, regulators and banking experts almost unanimously agree that regulatory reform is essential to ensuring that no bank is ever again too big to fail.
Unfortunately, there is far less agreement about the best approach for ending too big to fail. As a result, a number of prominent bank regulators and industry experts recommend a more drastic change: simply breaking up the biggest banks.
There is no question that too big to fail is an urgent problem in need of a solution. But there are huge complexities at almost every level. What is aEURoebig?aEUR? How big is aEURoetoo bigaEUR?? What is a aEURoebank?aEUR? What kinds of risk-taking are appropriate for a bankaEUR"and why? What do we know about the costs and benefits of different strategies?
This paper examines these issues in depth, including a look at measures of aEURoebigness" for the worldaEUR(TM)s 100 biggest publicly traded banks. It also includes a discussion of two major and legitimate concerns about big banks. The first is that big banks, through a concentration of power, will successfully lobby regulators for leniency and effectively receive greater leeway for excessive risk taking. The second concern is that the failure of a big bank can radiate instability throughout the financial system, forcing policymakers to bail out troubled big banks for the sake of the overall economy.
The authors see little evidence that the regulatory reforms now being enacted will solve the problem of too big to fail. They believe breaking up banks would be a mistake at this time, pointing out that there's surprisingly little evidence that big banks per se caused the recent financial crises. Breaking up some or all of the worldaEUR(TM)s biggest financial institutions would unleash forces with unpredictable consequences and considerable risks. Instead, policymakers may simply have to monitor the incremental reforms they have already begun to implement and make adjustments as the results come in.