January 29, 2023
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Op/ed: Banking Darwinism may finally solve “too big to fail” issue


By Mark Gilbert

Global market regulators are still wrestling with the “too big to fail” problem of protecting taxpayers from the consequences of a large financial institution collapsing.

Most initiatives focus on the right-hand side of the issue, demanding banks hold more capital to make failure less likely. There are hints, though, that a wave of Darwinism may address the left-hand words instead, with enlightened self- interest prompting banks to shrink.

Deutsche Bank AG, the biggest bank in Germany, is mulling a split that would see it hive off its consumer business, Reuters reported last week. Shareholders in the investment banking unit would be given shares in the spun-off lender. That follows a Goldman Sachs research note published in the first week of the year arguing that JPMorgan Chase should, as my colleague Matt Levine put it, “be broken into some number of pieces that is not one.”

While regulators shouldn’t be in the business of telling banks how big they can or can’t be, the authorities can quietly midwife the transformation of financial firms from behemoths to manageable entities. By tweaking the rulebooks to make some riskier businesses unprofitable to pursue — making the capital requirements so expensive that it’s almost impossible to make money, for example — regulators can nudge the necessary evolution of the banking system.

Wielding capital rules on a market-by-market basis to nudge trading activities is more intelligent than setting overall capital adequacy levels based on stress testing that no one has much faith in. (Do the models anticipate a 60-second, 30 percent jump in the Swiss franc, for example? Thought not.) It’s also less blunt than trying to impose some echo of the Glass-Steagall Act, the 1930s post-Depression legislation designed to separate investment and commercial banking, which is open to geographical abuse unless every country moves in lockstep.

In the post-crisis world, keeping so-called casino banking away from the mundane though essential business of holding deposits, issuing credit cards and making loans to consumers and businesses seems like an attractive outcome.

Philosophically, banks should be contemplating ways to cleave investment banking from commercial banking. Philosophy, though, is rarely at the heart of conglomerate decomposition. Banks will need a commercial imperative to contract and become more boring. Most industries only get around to breaking up when their share prices look likely to benefit. And bank shares could do with a lift.

The Goldman analysis, for example, reckons a two-part JPMorgan would be $38 billion more valuable than the current standalone company. In the U.S. stock market, the total return including dividends from the main S&P 500 index has outpaced the sub-index of financial stocks by more than 3 percent in the past year. In Europe, Deutsche Bank’s shares have underperformed the benchmark German DAX index in the past year, as the bank fell almost 34 percent while the rest of the market eked out a gain of a bit more than 5 percent.

In the meantime, life is getting harder in investment banking. The U.S. banks that have reported fourth-quarter revenue for fixed income, currencies and commodities have seen pretty big declines, according to figures compiled by Bloomberg Intelligence.

And banks are still too big. JPMorgan has a market capitalization of about $210 billion, second only to Wells Fargo’s $267 billion in U.S. banking, and bigger than Bank of America at $162 billion and Citigroup at $144 billion. In the past 18 months alone, JPMorgan has hired 7,000 people just to work on compliance. No wonder CEO Jamie Dimon complains about the un-American “assault” his bank is undergoing from regulators.

Moaning about oversight, though, won’t wash. Taxpayers are still smarting from footing the bill for the misadventures in banking. A better solution would be to have fewer businesses operating under a single umbrella, which in turn would reduce the regulatory burden.

The true test of whether “too big to fail” has been resolved will only come when a large bank is allowed to go bang without the authorities rushing to its aid with a bag of taxpayers’ cash. That will take courage on the part of the authorities. But it’d be a lot less scary if, by the time the next crisis rolls around, the banks have voluntarily slimmed down.

• Mark Gilbert writes for Bloomberg View. Reach him at magilbert@bloomberg.net.