Reining in large banks

The contours of Obama's plan to deal with the problems posed by large banks are slowly taking shape. Three elements have been spelt out:

• A levy of 0.15% on banks with assets of more than $50 bn
  
• Keeping banks out of proprietary trading on their own account, hedge funds and private equity
• Limits on bank size other than the present restriction of 10% of deposits

What will be the impact on bank size of all these put together? For now, US officials say it will prevent banks from growing larger. But that is just the immediate effect. When banks find they cannot grow earnings by growing bigger, that increases the incentive to sell off some of the assets and shrink. It also creates incentives against consolidation in banking.

So, yes, a modest beginning has finally made towards serious reform of banking instead of just increasing capital requirements. My own preference is to have regulatory limits on bank assets- say, 5-10% of GDP. We may get there eventually at the present rate but I would go for it without too much delay.

Secondly, I think it may not be advisable to ask banks to eliminate risky activities such as hedge funds and private equity. Instead, we may be better off setting exposure limits. More on all this in my ET column, At last, the remaking of banks?