Breaking up is hard to do: why ‘too big to fail’ banks can’t split up

After the financial crisis, many called for big banks to be split up. However, seven years later, many of these ‘too big to fail’ institutions remain as large as ever

After the financial crisis of 2008, many became concerned about the prominence of banks 'too big to fail', and called for them to be broken up. But in 2015, they are as big as ever
After the financial crisis of 2008, many became concerned about the prominence of banks 'too big to fail', and called for them to be broken up. But in 2015, they are as big as ever 

When the banking crisis struck in 2008, the calls from the industry for government assistance were panicked and clear. Many of these institutions teetering on the brink of disaster were deemed to be too big to fail, with an economic footprint so large that it would have a devastating knock-on effect for the rest of the economy.

In the aftermath, popular opinion dictated that such a situation, where huge private financial institutions required billions of dollars of state money to survive, could never happen again. Regulators set about debating whether to split these banks up, creating ‘firewalls’ around traditional savings operations, and allowing riskier investment funds to operate separately.

However, as the years have passed and the global economy has, somewhat half-heartedly, bounced back, so too has the attention on these firms. Many have remained as big as ever, and in some cases grown to be even larger. Despite this, there remain calls among many political figures for banks to be curtailed.

No single financial institution should have holdings so extensive that its failure would send the world economy into crisis. If an institution is too big to fail, it is too big to exist

Breaking banks
In Britain, the question of what to do with some of the big financial institutions has rumbled on ever since the crisis engulfed London and the wider UK economy. Demands for tighter regulations and enforced downsizing have not been enthusiastically met by many of the big firms, with HSBC rumoured to be considering relocating its headquarters to Hong Kong as a result. The company is also thought to be spinning off its UK retail banking division into a new firm, possibly named after the old Midland Bank that it bought over 25 years ago. Elsewhere, the partially state-owned and bailed-out Lloyds and Royal Bank of Scotland each had their investment divisions sold off or scaled back in recent years.

Another leading firm, Barclays, has faced its own challenges in how to modernise its operations. In July, the British banking giant ousted its CEO Antony Jenkins after just three years in the job, with many suggesting that his departure was down to the slow pace of his structural changes. Barclays was one of the financial institutions in the UK that was criticised as being too big to fail, even though it resisted the temptation to call for a government bailout at the height of the financial crisis, like rivals Royal Bank of Scotland and Lloyds.

Barclays’ investment banking division was seen as being a particularly divisive aspect of the operations, with some calling for it to be scaled back and the bank to refocus itself on its traditional consumer services. Jenkins was hired in 2012 with the task of addressing these issues and transforming Barclays into a more efficient and flexible business, not so wedded to its investment banking operations.

During his three years in charge there were rumblings of discontent among board members, who felt that reforms hadn’t been implemented fast enough and that Jenkins was dragging his feet. His temporary replacement, newly appointed chairman John McFarlane, is expected to clip the wings of the investment banking division that has come under fire for its role in the Libor and foreign exchange rate rigging scandals.

While there are still many people who bemoan the dominance of Britain’s biggest banks, a number of smaller and more modern financial institutions have emerged in recent years to challenge the hold of their larger counterparts. So-called challenger banks have sprung up across the UK; offering stripped back and efficient retail banking services than their more unwieldy rivals. Metro Bank is perhaps the most high-profile, receiving the first new banking licence in the UK in 2010 for over 100 years. It now has branches across the country. Regulators have since offered licences to six new banks. There now seems to be a suggestion that many of these bigger firms are out of tune with how the rest of the industry is changing.

Wall Street worries
Some political figures are also refusing to let the banks continue as before. In July, Democratic presidential candidate Bernie Sanders wrote an article that called for the big banks in the US to be broken up. Placing the blame for the financial crisis squarely at the door of Wall Street’s biggest banks, Sanders wrote: “Today, 99 percent of all new income goes to the top one percent. During the last two years, the 14 wealthiest Americans saw their wealth increase by $157bn, which is more wealth than is owned by the bottom 130 million Americans.

“In the midst of all this grotesque level of income and wealth inequality comes Wall Street. As we all know, it was the greed, recklessness and illegal behaviour on Wall Street six years ago that drove this country into the worst recession since the Great Depression. Millions of Americans lost their jobs, homes, life savings and ability to send their kids to college. The middle class is still suffering from the horrendous damage huge financial institutions and insurance companies did to this country in 2008.”

His desire to see the banks split up comes from the fact that the banks that required bail out funds in 2008 have grown even larger since then, despite calls at the time to clip their wings so such a situation wouldn’t be necessary again. “During the financial crisis of 2008, the American people were told that they needed to bailout huge financial institutions because those institutions were too big to fail. Yet, today, three out of the four financial institutions in this country (JP Morgan Chase, Bank of America, and Wells Fargo) are 80 percent larger today than they were on September 30, 2007, a year before the taxpayers of this country bailed them out. 80 percent!”

He added: “No single financial institution should be so large that its failure would cause catastrophic risk to millions of Americans or to our nation’s economic well-being. No single financial institution should have holdings so extensive that its failure would send the world economy into crisis. If an institution is too big to fail, it is too big to exist.”
The balance of power within the US economy towards the banking industry is, Sanders says, both wrong and a huge risk to the country’s economic prospects. With around $10trn in assets, this represents almost 60 percent of America’s GDP.

Sanders proposes a bill that would see regulators target the biggest financial institutions – including JP Morgan Chase, Bank of America, Citigroup, Goldman Sachs, Wells Fargo and Morgan Stanley – and break them up. His legislation has been endorsed by the Independent Community of Bankers of America, which represents six thousand community banks across the country.

While Sanders represents a populist wing of his party and is unlikely to overcome Hillary Clinton in the race for the Democratic nomination, his views reflect the growing discontent that many Americans have towards the financial behemoths that they feel were responsible for the economic downturn in 2008. His Democrat colleague Senator Elizabeth Warren has been a vocal opponent of the influence that Citigroup has in both the economy and in the political system in Washington.

Last year, she launched a scathing attack against Congress after the Dodd-Frank rules were weakened, and singled out Citigroup’s influence on politicians at the same time. “Many Wall Street institutions have exerted extraordinary influence in Washington’s corridors of power, but Citigroup has risen above the others. Its grip over economic policymaking in the executive branch is unprecedented”, said Warren.

Influential institutions
The global banking industry has emerged in the last year considerably stronger than the position it found itself in five years ago. While the fears of a banking crisis are no longer at the forefront of people’s minds, there still remain valid concerns over just how large and influential many institutions are.

While there are many valid arguments for curbing the influence of the world’s biggest banks to prevent a situation where they are too big to fail, many people argue that limiting the size of these institutions would in fact make it more expensive to consumers for traditional banking services. Forcing the banks to limit their scope and scale would result in them not being able to deliver price cuts to consumers, according to a 2012 report by the Federal Reserve Bank of St Louis’s David C Wheelock.

Wheelock wrote: “Although size limits could, in principle, end too big to fail, some research suggests that they could also raise the cost of providing banking services by preventing banks from exploiting economies of scale.”

Although America will elect a new president next year, the chances of it being someone who will genuinely curtail the power of these banks is slim. Democrat frontrunner Hillary Clinton is reported to have close ties with Wall Street, while most of her Republican rivals are unlikely to want to impose tougher regulations on the financial industry. However, the popular uprising that has seen Bernie Sanders emerge as a genuine challenger to Clinton for the Democrat nomination has shown that many people are still genuinely concerned about the industry’s sway.

While many people may well think that banks need regulations to curtail their influence, there are signs in the UK that competition is happening naturally as a result of challenger banks – hinting at how the industry might evolve worldwide. Smaller, more nimble firms targeting specific demographics might be the sort of institution that are able to survive an economic downturn while at the same time not receive the opprobrium of a weary public.