Column : Have we solved ‘too big to fail’?

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SummaryThat is not my pessimistic verdict; it is the market’s. Prior to the crisis, the 29 largest global banks benefited from just over one notch of uplift from the ratings agencies due to expectations of state support.

financial system as a whole or, more coherently, relative to GDP. Proposals of this type typically face two sets of criticism.

The first, practical issue is how to calibrate an appropriate limit. Recent research on the link between and financial depth and growth provides a way into this question. This research has suggested that there is a threshold at which the private-credit-to-GDP ratio may begin to have a negative impact on GDP and, in particular, productivity growth. By taking a view on this aggregate threshold, and on an appropriate degree of concentration within the financial system, an institution-specific threshold could be derived.

The second, empirical issue is whether size limits would erode the economies of scale and scope which might otherwise be associated with big banks. The empirical literature on these economies has, until recently, suggested they may be exhausted at relatively low balance sheet thresholds. But a number of recent papers have painted a more optimistic picture, with economies of scale found for banks with balance sheets in excess of $1 trillion.

Yet this evidence needs to be interpreted cautiously, not least because it fails to recognise the implicit subsidies associated with too-big-to-fail. These would tend to lower funding costs and boost measured valued-added for the big banks. In other words, the implicit subsidy would show up as economies of scale. Bank of England research has recently shown that, once those subsidies are accounted for, evidence of scale economies for banks with assets in excess of $100 billion tends to disappear. Indeed, if anything, there may even be evidence of scale diseconomies, perhaps consistent with big banks being ‘too big to manage’.

Too-big-to-fail is far from gone. It is even more important it is not forgotten. Further analytical work, weighing the costs and benefits of different structural reform proposals, would help keep memories fresh and policies on the right track.

The author is executive director, Financial Stability, Bank of England

www.voxeu.org

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