Many blame the largest banks for our most recent banking crisis, which leads to the question. Should “too big to fail” become “too big to exist?”
While the top five banks have assets worth more than 50 percent of the nation’s gross domestic product, it is clear that the safety and soundness of these institutions is essential for a healthy economy. Several high-profile figures have suggested that the big banks should be dismantled to ensure the health of the U.S. economy, including Federal Deposit Insurance Corp. board member Thomas Hoenig and Citigroup’s former chairman Sandy Weill. So Bank Director decided to poll bank attorneys to find out what they think.
Do you think the five largest banks in the United States should be broken up to lessen their systemic risk to the economy?
I don’t think anyone has made a persuasive case that breaking up the banks will reduce systemic risk. Breaking them up could actually increase systemic risk. For example, take a bank with $1 trillion in assets. Suppose it were broken up into 10 banks of $100 billion each. If the 10 smaller banks continue to engage in the same activities—e.g., taking deposits and making loans—all 10 would be just as likely to fail simultaneously and cause just as much systemic risk. Moreover, if they are less efficient risk managers, they may be more likely to fail. We will also lose the benefits of having banks with balance sheets and global footprints that match those of their customers.
—Randall Guynn, Davis Polk
Yes, unless the U.S. wants to move towards the European model of banking containing a very small number of banks. We have seen in the current banking crisis the near economic collapse of our financial systems and our economy resulting from the near failure of two to three of our largest banks. We need to spread the risk to our economy to a larger base of banks rather than fewer
—Bob Monroe, Stinson Morrison Hecker LLP
Economic crises (e.g., United States 2007-2009 and East Asia in the ‘90s) have generally originated from common exposures to risks (such as a fall in housing prices or a currency depreciation), rather than from the failure of a large bank bringing down others. Moreover, initiatives underway, including those to improve internal risk management processes and impose greater market discipline on large institutions, show promise as a means to reduce systemic risks. In light of the foregoing—and considering the unknown consequences of a forced break-up on the functioning of the financial system, the valuable services only being provided by the largest institutions, and the broad legal authority U.S. regulators already have to force a downsizing on a case-by-case basis—sound policy considerations underpin a more modest approach to “too big to fail.”
—Gregg Rozansky, Shearman & Sterling LLP
No. Simply breaking up a bank based on size alone is a blunderbuss approach to systemic regulation, which may not achieve its intended results and may do unnecessary harm to the banks involved. Systemic regulation should be based on a reasoned analysis of actual systemic risk presented by individual financial institutions based on their individual structures, activities and risk profiles. Similarly, the decision to break up a large financial institution should be based only on the same type of analysis, and only if the financial institution poses a plain risk to the financial system, and there are not reasonable assurances that the institution can be adequately managed or regulated. Financial regulators, however, should have the authority to require risk-reduction downsizing or divestments of business lines and activities under appropriate circumstances, subject to clear standards and adequate due process protections.
—Charles Horn, Morrison Foerster