So, a consultant walked into a bank branch one day and it really isn’t all that funny. Although I happily do most of my banking in the sublime reaches of a private bank, I was advised to visit a regular one to open a long-overdue health-savings account. Three trips to a branch, two promises to set up an appointment that never materialized, an effort to do this online that failed in the face of mysterious security questions, and repeated efforts to call the branch (a few times the phones simply didn’t work) and still no HSA. I’m sure all this “customer service” has saved the bank billions, boosting its operating-efficiency ratio above appallingly abysmal, but what of its future? This simple inability to answer a question and sell a product speaks not only to the awesome challenges CEOs face in their bewildering empires, but also why so many policy-makers think the solution is simple break-up.
Perhaps stung by all the accusations that Federal Reserve Banks are too chummy with the bankers on their boards, the move in the Federal Reserve System to take on TBTF is gaining astonishing traction. Neel Kashkari at the Minneapolis Fed kicked this off in grand style last week at a high-profile Brookings event that sparked not just surprising media coverage, but also a coveted spot on Wednesday’s PBS NewsHour show for opinion-leaders.
On Thursday, the president of the St. Louis Fed, James Bullard, endorsed the Kashkari crusade, arguing that the U.S. financial system would be safer and more innovative if the biggest banks were broken up. Others at the FRB – Gov. Tarullo, for example – are not so much opposed to breaking up big banks as troubled by the elusive formula to make it feasible. His solution so far – one seconded by Chair Yellen – is not to break up banks by fiat, but to reduce their vaunted “systemic footprints” by strangling them.
Calls from the marble precincts of the Federal Reserve System add a lot of gravitas to the more inflammatory calls across the campaign trail. Proponents of break-up may well build on them to go after big banks either by size thresholds, by permissible activity (the Glass-Steagall brigade), or via giant leverage-capital requirements (sure to be the opening salvo at Minneapolis’ first hearing on TBTF in April). However, Mr. Kashkari raised one idea which could gain real momentum after all the practical obstacles to other TBTF cures become clear: making big banks into utilities. Would this work – that is, could we break up big banks and still have a functioning financial system?
The reason I think the other ideas – size thresholds, activity bans, and 25%+ leverage requirements – will founder is that none of them reckons with what big banks actually do. Most reformers premise their positions on an old-style view of banking – nice institutions that take people’s deposits and make loans to customers big and small across the land. Traditional financial intermediation is of course the lifeblood of banking, but it’s no longer the reason we have banks. The real value-add from big banks that no other financial enterprise large or small yet can tackle are financial-infrastructure services. These include payment, settlement, and clearing services along with custody banking, market-making and other activities we’re starting to miss so much as banks exit these operations.
Almost all of these activities – dubbed critical infrastructure in resolution parlance – are low-margin, high-volume ones that big banks can do precisely because they’re big. It’s getting hard to do them now because of new rules like the supplementary leverage ratio and LCR, but big banks are still hanging in with no substitute competitor nipping at their heels. When big banks get out of a business – market-making, for example – it simply gets smaller. The exception to this is in clearing, where big banks are being forced to make way for CCPs. If you think this solves for TBTF, take another look.
The FRB’s GSIB-regulatory framework is a de facto way to make the biggest banks the functional equivalent of utilities but without the de jure structure that in fact makes acknowledged utilities work so well. In his speech, Mr. Kashkari suggested that bank regulation be modelled on that for power generation without mentioning that these same low-margin, high-volume, critical-infrastructure businesses are not just regulated for safety and soundness, but also granted monopoly power.
Being a monopoly means that even regulated products governed by governmental pricing attract investors because the reward for burdensome utility regulation is stable, long-term, low-risk return. That may well make sense for the financial system’s critical infrastructure, but we need first to understand that it’s there, decide how such functions are to be governed in or out of big banks, and then determine how many providers can safely protect the financial system’s plumbing with a reasonable rate of return. Simply eviscerating big banks in hopes they go away will lead some critical functions to flee to new, systemic firms, others to head to greener foreign pastures, and some just to shut down. When they’re gone, we’ll miss them.