Re-Engineer Banks, Don't Break Them Up
Big banks provide benefits, provided their risks are managed
July 18, 2013
We can sit below a volcano, not knowing the probability of it exploding but having a decent guess as to the devastation it would cause. This is the bank risk regime of today. We would really want to sit next to a seismometer, continually measure the increasing volcanic activity, and devise a system that proactively prevents the explosion. This is the risk regime we need.
While nature's fury is hard to control, a proactive risk management regime for banks is both needed and implementable. Regulators must look to reward banks for risk -adjusting their culture and re-engineering their institutions, not look to break them up as the means of disciplining bad behavior.
There are benefits to preserving these banks if society can manage their risk and support their stabilizing effects on economic order. Wasn't it the clients of the banks that too became global that asked for multiple services under one roof available anytime, anywhere, any way?
Much of what passes for new is ideas of the past made acceptable by the rush for palliatives for our financial crisis that merely tweak the regulatory architecture of a failed risk regime. A prime example is the "living will" concept providing guidance to regulators to dismember a "too big to fail" bank.
A living will requires a full inventory of assets and liabilities, systems and interconnections, as well as entanglements with all outside facilities and organizations. That no one knows how these banks had been built is apparent to everyone. That the blueprint for these financial behemoths was missing is unquestioned. How then, can a hastily prepared living will or an increase in capital actually be used by regulators to dismantle or recover "too big to fail" banks from serious capital depletion or failure?
We will surely pull the wrong brick or tug the wrong pipe and topple the whole edifice. Best to place society's bet on slowly reengineering "too big to fail" banks.
This effort is more doable now that the Group of 20 is implementing a global identification system for financial market participants and the financial products they own. It is amazing that the industry and its regulators survived without such a means to aggregate and view financial transactions electronically.
Risk-adjusting the financial system will take time. It starts with a positive view of building something better, re-engineering banks, not breaking them up.
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