When is a bank small enough to fail?
If banks shouldn’t be “too big to fail” how small must they be before we allow them to collapse? It’s the question the Bank of England’s governor must answer.
Mervyn King has renewed his call for a UK equivalent of America’s old Glass-Steagall Act, which effectively split retail banking from investment banks. But the history of the recent crisis tells us that neither size nor specialisation were barrieres to going bust.
Northern Rock and Bradford & Bingley were plain vanilla banks that lent money to the public secured on property. They were not trading on their own account or investing in complex financial instruments. Yet they got into trouble and, despite being small compared with the major banks, the state felt obliged to save them.
Lehman Brothers, on the other hand, was a purely investment bank. When it hit trouble it was allowed to fail but the consequences were catastrophic. If a similar bank got into similar trouble you can bet that this time it would be saved, just as Bear Stearns was.
So when crunch comes, there is a case for saving both big investment banks and small retail banks. Who then do we allow to fail?
Certainly HBoS and RBS proved too big to be allowed to fail. But while they were taking positions on their own account they were not investment bankers acting for third parties. Their downfall was to mix retailing banking with business banking, but that is not the split the Bank governor is seeking. And nor could he. Banks take deposits from the public and lend them to business: that’s how banking works.
HSBC and Barclays, which accepted no government bail-out, would regard it as unfair to be forced to split their investment banking and consumer activities, but if they did, either half of the division would still be too big to fail. And as global operations, hiving off the UK retail banks would not be easy.
Mervyn King has identified a problem but his solution would not help UK banking or its corporate customers – which is why the Treasury and FSA regulators are against splitting functions. Imposing tough capital requirements on banks undertaking risky trading and on banks whose size makes them risky looks a better way of thinking small. But when retail customers could be hit or the banking system is threatened, the state will always be under pressure to intervene.
