Big Banks Have Risks—and Benefits

By Gre Ip of the WSJ. Excerpts:

"The preoccupation with banks’ size is well-founded. The havoc when big banks fail, and the perception the government won’t let that happen, enables them to borrow cheaply and grow still larger.

Yet as in technology, size confers unique benefits in banking: economies of scale in technology, branding and risk management; network effects that attract customers; and broad geographic and sectoral diversity. If regulators ignore these attributes while dwelling solely on the danger of size, they risk leaving the economy worse off, not better."

"One of the lessons of the financial crisis was companies such as American International Group, an insurer, can be just as intertwined with the financial system as banks. If rules are tightened only on banks, risky activity is likely to migrate to these nonbank institutions."

"Because a financial crisis, like a terrorist attack or pandemic, is so unpredictable, the value of preventing one is not easily quantified. But that too easily becomes an excuse to ignore costs altogether, whether to civil liberties or economic growth."

"Big banks are no match for Apple in the affections of hipsters, Hollywood or Mr. Sanders, but one constituency seems to rather like them: consumers. Their satisfaction ratings have risen steadily since 2010 and now top those of regional banks, according to J.D. Power."

"Investment in technology has huge fixed and low marginal costs, and thus gives an advantage to size. The Bipartisan Policy Center report notes large banks were the first to offer automated-teller machines, online bill payment and small-business credit scoring. Economies of scale may also apply to risk management and regulation; J.P. Morgan now employs 43,000 staff in “controls,” up from 24,000 in 2011, and 18% of total head count.

Big banks also make big mistakes, but this doesn’t automatically mean they are more prone to failure. With size comes greater diversification across regions, industries and business lines, and thus less volatile revenue. One study found that when geographic restrictions on branch banking fell, more-efficient banks gained market share, loan losses declined and customers benefited."

Click here to read what Paul Krugman said.

"The easy slogan here is “Break up the big banks.” It’s obvious why this slogan is appealing from a political point of view: Wall Street supplies an excellent cast of villains. But were big banks really at the heart of the financial crisis, and would breaking them up protect us from future crises?

Many analysts concluded years ago that the answers to both questions were no. Predatory lending was largely carried out by smaller, non-Wall Street institutions like Countrywide Financial; the crisis itself was centered not on big banks but on “shadow banks” like Lehman Brothers that weren’t necessarily that big. And the financial reform that President Obama signed in 2010 made a real effort to address these problems. It could and should be made stronger, but pounding the table about big banks misses the point."