Crisis Shows Bigger Banks Are Less Stable

Bank of England official Andrew Haldane said the crisis has shown that big banks are less stable than smaller ones and called for a revamp of lenders’ business models to make the financial system more resilient.

“There is not a scrap of evidence of economies of scale or scope in banking — of bigger or broader being better — beyond a low size threshold,” Haldane, the bank’s executive director for financial stability, said in a speech yesterday in Leeds, England. “Big banks have if anything been found to be less stable than their smaller counterparts, requiring on average larger-scale support.”

Finance minister Alistair Darling has stopped short of suggesting a breakup for the biggest lenders in his plans to revamp rules governing the industry. Nobel-Prize winning economist Joseph Stiglitz said this week that some banks may have become even larger now, evidence that financial system problems are “worse than they were in 2007.”

“Loss of trust has been the root cause of the devastating impact felt globally since the credit crunch began,” said Haldane. “It also explains why the road to recovery in credit, and thus in the real economy, may be long and winding.”

King said earlier this year that banks that are too big to fail are too big to exist. The U.K. opposition Conservative Party says it will scrap the Financial Services Authority regulator and hand powers over lenders deemed too big to fail to the central bank if it wins the next election due by June 2010.

Darling’s Plans

Darling has pledged more intrusive supervision of Britain’s largest banks, forcing them to hold more capital and taking steps to improve competition and curb executive pay. His recommendations stop short of requiring limits on their size.

Haldane said that there may be “diseconomies of scale” for banks to enable long-term relationships between borrowers and lenders.

“The desire to make loans a tradable commodity led to a loss of information, as transactions replaced relationships and quantity trumped quality,” Haldane said. “Within the space of a decade, banks went from monogamy to speed-dating.”

Haldane also recommended that banks not bundle services or diversify to prevent spillovers if one part of the business runs into trouble. He said that the business model of a mutual or a building society, where the banks’ savers and borrowers are also its owners, would diminish incentives for bankers to engage in risky deals for higher profits.

Haldane called for banks to initiate change instead of waiting for regulators to impose it.

“In repairing public trust, it would be preferable if banks were seen to be initiating root and branch reform themselves, rather than having it thrust upon them,” he said.

Enhanced regulation measures including higher capital and liquidity buffers will help to cleanse balance sheets, though they may be insufficient to rebuild public confidence in the banking system, Haldane said.

“It is lack of trust — and hence credit — that may shape the recovery,” Haldane said. “Based on past evidence, as the Governor has noted recently, we might anticipate a protracted period of repair.”

(Bloomberg)