Friday, August 03, 2012

A return to Glass Steagall?

Sandy Weill, the architect of Citibank's transformation into a huge universal bank, has triggered a huge debate by suggesting a separation of commercial banking from investment banking alone the lines of Glass-Steagall. Like many others, he seems to think that banks have become too big to manage and that it is not correct to have depositors money funding trading activities.

In an article in FT, Luigi Zingales of Chicago university, throws his weight behind G-S. He  thinks  a straight separation would be superior to the restrictions on trading proposed under the Volcker rule. He also argues that separation would lead to more numerous and smaller investment banks and this would make for greater liquidity. Further, today's universal banks wield too much clout and this must be curbed.

I am not persuaded by these arguments. For one thing, Zingales mixes up bigness with scope of operations; even if investment banking were hived off, many commercial banks would still be too big for comfort. Secondly, there are benefits to banks as well as customers from combining commercial and investment banking activities. Independent investment banks would have to access funds at a higher cost, for instance. Banks can offer loans at a lower price if they can make up through fee income from investment banking. Indeed, it is the perceived benefits from combining operations that brought about the combination in the first place.

We must contain risk not through separation but simply through superior risk management that is driven by regulation. One element in this approach could involve shrinking the size of banks, although the mechanics of this would need to be worked out. (For instance, who will buy the assets in today's conditions?). Another element would be public ownership of a few large banks; this would reduce incentives for big gambles that apply under private ownership. The thrust has to be on improved regulatory norms for risk that go well beyond Basel 3 norms.

More in my ET column, How not to break up banks

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