Thursday, June 18, 2009

This is a debate which needs to be aired in the widest possible way.

TO BE NOTED: From the FT:

Insight: When it comes to global banks, size matters

By Gillian Tett

Published: June 18 2009 19:37 | Last updated: June 18 2009 19:37

Do the big global banks need to be cut down to size? That question has been hovering, half-stated, over the financial system ever since Bear Stearns blew up.

But until this week, most policymakers were reluctant to attack the big banks too publicly, in terms of size. After all, this has been the decade when global leaders – or the infamous “Davos man” – worshipped at the altar of free-market capitalism, globalisation and innovation.

Inside the Davos creed it was long assumed that private sector banks had the right to be as big as the market would bear, since scale was supposed to make finance efficient, and thus better able to promote innovation.

Now that creed has crumbled. The collapse of Lehman Brothers has shown the havoc that can ensue when large, interconnected banks implode.

Worse, in the aftermath of Lehmans, as governments have rushed to rescue the banks, the potential fiscal costs – and risks – have become clear. In the UK, for example, the balance sheet of the Royal Bank of Scotland at its peak was not far from the size of the British economy.

Thus, a new debate about “size” is finally starting. On Wednesday Mervyn King, Bank of England governor, warned that regulators might need to rethink the wisdom of letting some banks become “too big to fail”. In Washington, the Obama administration has voiced similar thoughts, albeit more diplomatically and obliquely.

On Thursday, though, an even more interesting and outspoken intervention emerged. Philipp Hildebrand, the next head of the Swiss National Bank, revealed that the central bank was considering introducing “direct and indirect measures to limit the size” of large international banks (which in the case of Switzerland means Credit Suisse and UBS).

“A size restriction would of course be a major intervention in an institution’s corporate strategy,” Hildebrand, the central bank’s current vice-chairman, observed with masterful understatement. “Naturally the SNB is aware that there are advantages to size. [But] in the case of the large international banks, the empirical evidence would seem to suggest that these institutions have long exceeded the size needed to make full use of these advantages.”

Now, to be fair to Hildebrand, I should stress that he only presented size controls as a policy of last resort. He is not, in other words, demanding the immediate break-up of UBS or Credit Suisse.

For what really worries the SNB is not any abstract issue about size, but the very practical problems that emerge when big banks collapse due to the absence of any international regime to wind down a large, cross-border bank smoothly – or restructure its operations.

What Hildebrand really wants to see is a credible international framework to handle big bank failures in a way that does not blow up the financial system. Call it, if you like, a call for a global Chapter 11 regime for banks.

Hildebrand is also a realist who spent the early years of his career working for a US hedge fund. He does not consider it a good trading bet to sit around waiting for global bureaucrats to actually produce a global insolvency regime any time soon. Hence his determination to start talking about plan B – and to stop banks from becoming too big if there is no global framework in place to deal with a collapse.

Whether Hildebrand’s idea will actually fly is unclear. Some Swiss politicians hate the idea of introducing measures that might leave their banks at a disadvantage relative to others. And Credit Suisse and UBS have powerful lobbying muscle, precisely because they are so ... er ... big.

Hildebrand is not the only western policy maker mulling these concepts. And he has successfully stuck his neck out before. Last year he was the first western central banker to call for the use of a leverage ratio to help monitor bank capital levels. The concept was loathed by Swiss banks, but is now being introduced into Switzerland and may yet be incorporated into a revamped Basle code.

So it will be worth watching closely to see how the SNB’s debate about size curbs develops. And I, for one, think the proposals deserve to be taken seriously. Quite apart from the fact that the world is littered with banks which are too big to fail (but too costly to keep saving), the world also has banks that are too big to manage. The sorry tale of UBS’s disastrous dealing with subprime securities is a case in point. So are the sagas of Citigroup and Merrill Lynch. Thus making banks smaller may not only be good for non-banking taxpayers, but it might yet bring some real benefits for bankers too – not just in small countries (such as Switzerland) but places which tend to worship size too (such as the US). This is a debate which needs to be aired in the widest possible way."

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