Social Europe

politics, economy and employment & labour

  • Themes
    • Global cities
    • Strategic autonomy
    • War in Ukraine
    • European digital sphere
    • Recovery and resilience
  • Publications
    • Books
    • Dossiers
    • Occasional Papers
    • Research Essays
    • Brexit Paper Series
  • Podcast
  • Videos
  • Newsletter
  • Membership

The Central Problem With Banks Is “Too Complex To Fail” Not “Too Big To Fail”

John Kay 19th April 2016

economy

JohnKayround

John Kay

Poor Bernie Sanders. How can you expect to become US president if you are not familiar with the relative spheres of competence of the Federal Reserve and Treasury department in the supervision of the nation’s banks? If you are not au fait with the different roles of the Securities and Exchange Commission, the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency?

The senator from Vermont was part of the Congress that passed the Dodd-Frank Act extending financial regulation. Yet he has not even mastered the thousand pages or so of the act, far less the regulations and explanatory documents that have been published since.

Mr Sanders’ recent stumbles illustrate a misdirection in his attack on the banking establishment. The central problem is not so much “too big to fail” but “too complex to fail”: Lehman was a systemically important financial institution but not an important financial institution. Nor was it a big one; it had fewer employees than Citigroup today has compliance staff. Lehman’s collapse created major problems for the global financial system because of the extent of its interactions, with more than 1m outstanding contracts at the time of its bankruptcy. Similarly, Long Term Capital Management was insignificant in size when it failed but capable of massive impact by virtue of the exposure of other institutions to its activities.

There is some force in the claim that size in banking has actually been conducive to stability. Britain had no banking crisis in the Great Depression because the sector was highly concentrated. The US had many failures because the fragmentation imposed by restrictions on interstate banking meant that many banks lacked sufficient geographical or sectoral diversification to weather losses.

Ahead of the global financial crisis , it was argued that the growth of securitisation and other complex instruments similarly contributed to financial resilience. The reverse proved to be the case; trade between institutions represented concentration and multiplication of risks rather than diversification.

Complexity is the enemy of stability. Financial conglomerates have become too diverse and sprawling for their chief executives or boards to understand what they do. The same complexity creates endemic conflicts of interest and is associated with cross subsidy between activities. There are fundamental differences in the cultures required to trade derivatives, to give private financial advice to big corporations, to manage assets on behalf of savers and to provide an efficient retail banking service.


Become part of our Community of Thought Leaders


Get fresh perspectives delivered straight to your inbox. Sign up for our newsletter to receive thought-provoking opinion articles and expert analysis on the most pressing political, economic and social issues of our time. Join our community of engaged readers and be a part of the conversation.

Sign up here

And these conflicts and interdependencies undermine resilience. Vertical chains of intermediation, which channel funds directly from savers to the uses of capital, can break without inflicting much collateral damage. When intermediation is predominantly horizontal, with intermediaries mostly trading with each other, any failure cascades through the system, as happened with Lehman. Today the assets of major financial institutions are predominantly the liabilities of other financial institutions; and vice versa.

These issues are compounded by the regulatory complexity that follows from attempts to monitor behaviour in impossible detail. As the size of the Dodd-Frank legislation shows, we have locked ourselves into a spiral in which regulatory complexity gives rise to further organisational complexity and the construction of yet more esoteric instruments. Even if legislators had better motives than the present corrupting structure that US campaign finance seems to allow, they cannot hope to have more than a basic knowledge of the rules they promulgate or the workings of the regulatory institutions they have created.

So should we break up banks? Bring it on, Bernie.

This column was first published by the Financial Times and on John Kay’s Blog.

John Kay

John Kay is Visiting Professor of Economics at the London School of Economics and a regular columnist for the Financial Times.

You are here: Home / Economy / The Central Problem With Banks Is “Too Complex To Fail” Not “Too Big To Fail”

Most Popular Posts

Ukraine,fatigue Ukraine’s cause: momentum is diminishingStefan Wolff and Tetyana Malyarenko
Russia,information war Russia is winning the information warAiste Merfeldaite
Nanterre,police Nanterre and the suburbs: the lid comes offJoseph Downing
Russia,nuclear Russia’s dangerous nuclear consensusAna Palacio
Belarus,Lithuania A tale of two countries: Belarus and LithuaniaThorvaldur Gylfason and Eduard Hochreiter

Most Recent Posts

G7,BRICS,China,Russia G7 versus the BRICS: taking stock in 12 figuresThorvaldur Gylfason
solar energy,photovoltaic,Europe,EU,PV Powering up: the EU and solar energyFrancesco Crespi, Dario Guarascio, Serenella Caravella and Giacomo Cucignatto
Nagorno-Karabakh Nagorno-Karabakh: it’s not over yetSvante Lundgren
Sweden,climate,green Sweden’s climate policy—off the railsLisa Pelling
Biden,Detroit,UAW,strike Detroit, Joe Biden and a union renaissancePaul Knott

Other Social Europe Publications

strategic autonomy Strategic autonomy
Bildschirmfoto 2023 05 08 um 21.36.25 scaled 1 RE No. 13: Failed Market Approaches to Long-Term Care
front cover Towards a social-democratic century?
Cover e1655225066994 National recovery and resilience plans
Untitled design The transatlantic relationship

Hans Böckler Stiftung Advertisement

WSI European Collective Bargaining Report 2022 / 2023

With real wages falling by 4 per cent in 2022, workers in the European Union suffered an unprecedented loss in purchasing power. The reason for this was the rapid increase in consumer prices, behind which nominal wage growth fell significantly. Meanwhile, inflation is no longer driven by energy import prices, but by domestic factors. The increased profit margins of companies are a major reason for persistent inflation. In this difficult environment, trade unions are faced with the challenge of securing real wages—and companies have the responsibility of making their contribution to returning to the path of political stability by reducing excess profits.


DOWNLOAD HERE

ETUI advertisement

The future of remote work

The 12 chapters collected in this volume provide a multidisciplinary perspective on the impact and the future trajectories of remote work, from the nexus between the location from where work is performed and how it is performed to how remote locations may affect the way work is managed and organised, as well as the applicability of existing legislation. Additional questions concern remote work’s environmental and social impact and the rapidly changing nature of the relationship between work and life.


AVAILABLE HERE

Eurofound advertisement

Eurofound Talks: does Europe have the skills it needs for a changing economy?

In this episode of the Eurofound Talks podcast, Mary McCaughey speaks with Eurofound’s research manager, Tina Weber, its senior research manager, Gijs van Houten, and Giovanni Russo, senior expert at CEDEFOP (The European Centre for the Development of Vocational Training), about Europe’s skills challenges and what can be done to help workers and businesses adapt to future skills demands.

Listen where you get your podcasts, or for free, by clicking on the link below


LISTEN HERE

Foundation for European Progressive Studies Advertisement

The summer issue of the Progressive Post magazine by FEPS is out!

The Special Coverage of this new edition is dedicated to the importance of biodiversity, not only as a good in itself but also for the very existence of humankind. We need a paradigm change in the mostly utilitarian relation humans have with nature.

In this issue, we also look at the hazards of unregulated artificial intelligence, explore the shortcomings of the EU's approach to migration and asylum management, and analyse the social downside of the EU's current ethnically-focused Roma policy.


DOWNLOAD HERE

About Social Europe

Our Mission

Article Submission

Membership

Advertisements

Legal Disclosure

Privacy Policy

Copyright

Social Europe ISSN 2628-7641

Social Europe Archives

Search Social Europe

Themes Archive

Politics Archive

Economy Archive

Society Archive

Ecology Archive

Follow us

RSS Feed

Follow us on Facebook

Follow us on Twitter

Follow us on LinkedIn

Follow us on YouTube