Lord Turner on “too big to fail”: Obama/Volcker proposals are seriously being considered
04 March 2010
He presented possible solutions including higher equity requirements for larger banks, using resolution and recovery plans to encourage them to structure themselves into separable legal entities, either by geography or by function.
The Committee is investigating how to deal with large systemically important institutions. This is the key issue on which the Financial Stability Board’s Standing Committee on Regulatory and Supervisory Cooperation, which Lord Turner chairs, will be focused throughout this year, with recommendations in time for the G20 November summit in Seoul.. The menu of possible solutions being considered includes:
· equity capital requirements which are higher for larger banks
· using resolution and recovery plans to encourage banks to structure themselves into separable legal entities, whether by geography – i.e. separate national subsidiaries, or by function – separate subsidiaries for deposit-taking and trading activities; and
· and restrictions on the breadth of activities which different types of banks can perform.
The first is that addressing the too-big-to-fail problem is a necessary but not sufficient response to the financial crisis. Discussion about the costs of the crisis often focuses on the costs of public rescue – exceptional central bank liquidity support, treasury funding guarantees, and equity injections. But these overt costs, while significant, may turn out to be small relative to the overall costs of financial instability. Central bank liquidity support is provided at market or penal rates and may turn out to be profitable: guarantees are provided for a fee and may well not be called and the equity stakes may rise in value in the future, and even if they do not, are not huge relative to GDP. It is quite possible that the total overt costs of the UK’s big bank rescues may not exceed 5-10 per cent of GDP, and perhaps considerably less as indeed was the case in the Swedish banking crisis of the 1990s.
But following this crisis UK fiscal debt may rise by 50 per cent of GDP and many people have lost jobs, houses and income. The key driver of these much bigger costs is volatile credit supply, first underpriced and too easily available, then severely constrained. And that problem might continue even if we successfully addressed the too-big-to-fail problem. If the big UK banks which needed to be rescued in autumn 2008 had been multiple smaller banks, we might still have had just as much over-exuberant lending to commercial real estate developers, funded by risky short-term wholesale deposits. Tighter capital and liquidity requirements on all banks, and new counter cyclical macro-prudential tools which constrain credit supply in the upswing, may be even more important than fixing the too-big-to-fail problem.
Second, the narrow banking debate is important. The FSB Committee is looking at measures related to breadth of activities as well as to size, considering for instance the Obama/Volcker proposals. In this arena too we must not confuse ‘necessary’ with ‘sufficient’ action. Lehman Brothers was not a deposit-taking bank, but was systemically important. Any idea that we can define narrow banks and then take a hands-off approach to the rest of the system, far from being intelligent radicalism, is just a new version of the pre-crisis conventional wisdom that if only we could identify and remove some specific market imperfections, financial instability would disappear. Position-taking by highly leveraged institutions needs to be regulated wherever it occurs.
But there are arguments for limiting the extent to which deposit-taking banks undertake proprietary trading which, in the words of the Obama/Volcker announcement, is unrelated to customer service. The issue is what means can achieve that objective. Having discussed this with Paul Volcker, Lord Turner believes we are in full agreement on the means and that capital requirements for trading activities will be key. He also believes that the idea that there is some fundamental divergence between the Volcker proposals and the way the FSB is addressing this issue, is a confusion in an important debate.
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