Splitting big banks

Published: December 2 2009 14:52 | Last updated: December 2 2009 18:32

What is the opposite of the urge to merge? The itch to ditch? Many reckon big banks should be broken up not least because the
financial crisis has increased the de facto government guarantees swaddling everything from casino-style punts to bog-standard
lending. Amendments to a US reform bill would allow regulators to force divestitures on banks deemed too big to fail. Meanwhile,
chief executive candidates at Bank of America apparently have concerns about the monolith in its current form.
The truth is that diversification in banking is of dubious worth. In spite of much talk about cross-selling and the needs of global
clients, more diversified banks have in reality used their supposedly more stable earnings streams to justify ever higher levels of
leverage. Meanwhile, their breadth, intended to offset idiosyncratic risk within a bank, actually increased the fallout from shocks to the
system, argue Bank of England economists. All banks got bigger, but in much the same way.
Policymakers, however, show little appetite for dismembering banks and the idea of separating them into discrete businesses within
a single structure is a fantasy. Regulators will probably prefer to de-risk big banks via blanket leverage requirements and higher risk
weightings for certain assets. They should also ensure that low-risk assets really reflect low-risk banking activities, rather than acting
as collateral for the latest punt.
Restricting leverage may force higher-octane activities to be ditched. But that is no bad thing. In the unregulated wilderness, investors
provide the discipline. Hedge funds, for example, operate with a fraction of large banks gearing. The challenge then for regulators
would be to make sure that these entities remain genuinely separate. Smaller banks are only half a solution. The trick is to control their
urges to seek out riskier business.