Are Big Banks Necessary?
By John Heltman
WASHINGTON — The drive to break up the big banks has won a surprising number of adherents from both sides of the political spectrum — everyone from Neel Kashkari, the Republican head of the Federal Reserve Bank of Minneapolis, to Bernie Sanders of Vermont, the Democratic socialist who has made it the heart of his campaign. The issue is usually analyzed from a political standpoint, focusing on whether a breakup is possible and how it could be done. But the topic raises a critical question that is seldom asked, much less answered: Is there a legitimate, coherent business case to be made for the largest and most complex banks to stay large and complex? Do megabanks serve a critical function that justifies their undeniable risk to the financial system? Karen Shaw Petrou, managing partner at Federal Financial Analytics, said those activities [that big banks are able to take advantage of due to their size, such as payment and clearing services, triparty repurchase agreements, prime brokerage services, or custody banking] are “fundamental to the U.S. financial markets’ functioning and infrastructure,” but pointed out that they could mostly be performed by smaller banks in a disaggregated system. Such an arrangement, however, would be less efficient, and therefore more expensive. “All of the efficiencies of the G-SIBs come with added risk,” Petrou said. “You would have less risk” if the banks were broken up, “but it would be at considerably less efficiency.” Petrou also noted out that many of these activities do not inherently have to be performed by banks — they could almost as easily be performed by very large private equity firms or other financial services firms. If those firms were to take up such activities, however, they would likely have to be very large in order to take advantage of the same efficiencies. A bank breakup would move the risk to another part of the economic system — but it wouldn’t eliminate the risk.