The elephant in the room: The need to deal with what banks do

Abstract

Contagion risk and counterparty failure have been the main hallmarks of the current crisis. While some large diversified banks that focused mainly on commercial banking survived very well, others suffered crippling losses. Sound corporate governance and strong riskmanagement culture should enable banks to avoid excessive leverage and risk taking. The question is whether there is a better way, via leverage rules or rules on the structures of large conglomerates, to ensure volatile investment banking functions do not dominate the future stability of the commercial banking and financial intermediation environment that is so critical for economic activity. While there is a main consensus on the need for reform of capital rules, dynamic provisioning, better co-operation for future crises, centralised trading of derivatives etc., the question is whether such reforms will be sufficient if they do not address contagion and counterparty risk directly. The world outside of policy making is waiting for a fundamental reassessment of banks’ business models: what banks are supposed to do and how they compete with each other. It is the “elephant in the room” on which some policy makers have not yet had the time or inclination to focus. This article emphasises not only the need for transparent and comparable accounting rules and for improvements in corporate governance, but also supports the imposition of a group leverage ratio to provide a binding capital constraint (that Basel riskweighted rules have been unable to achieve) and proposes a Non- Operating Holding Company Structure (NOHC) – reforms that are essential to deal with contagion and counterparty risk that are so integral to the ‘too big to fail’ issue.

Financial Consumption and the Cost of Finance: Measuring Financial Efficiency in Europe (1950–2007)

“…Second, entry by financial intermediaries entails that investor portfolios shift to riskier and more expensive financial products (Gennaioli et al 2013). Third, the "too systemic to fail" problem emerged following banks' restructuring, which increased banks leverage ratio and encouraged risk-taking while creating privatized short term gains and socialized long term losses (Blundell-Wignall et al 2009). Therefore, following Philippon's (2013) study of the US case, this paper proposes to calculate the unit cost of financial intermediation for Germany, France, the UK, and Europe 1 as a whole from 1950 to 2007, as a way of assessing the efficiency of financial services production.…”

The IMF's Rethink of Global Banks: Critical in Theory, Orthodox in Practice

“…He argued that banks had collectively migrated to business models that prioritized the production and trading of risk (through securitization and off‐balance sheet instruments), leveraged proprietary trading, market making, and global management of asset and liabilities. More politicized still, the Organisation for Economic Co‐operation and Development's Adrian Blundell‐Wignall, Wehinger, and Slovik () and Blundell‐Wignall, Atkinson, and Roulet () observed how Citigroup, Bank of America, UBS, Barclays, and Deutsche Bank had become too big to fail through tax (havens) arbitrage and aggressive lobbying. Drawing on Shin (), Janet Yellen (), of the U.S. Federal Reserve, noted that networks of mutual exposures became increasingly complex because banks could only grow by trading with each other.…”

The Business Models of Large Interconnected Banks and the Lessons of the Financial Crisis

“…2See: Blundell-Wignall (2007a; b); Blundell-Wignall and Atkinson (2008; 2010; 2011; 2012); and Blundell-Wignall, Wehinger and Slovik (2009).…”

“…15For example, if mark-to-market securitised mortgages guaranteed by CDS are held on a traditional bank's balance sheet, as with Northern Rock, and these products give rise to different prudential considerations than would apply to amortised cost-accounting loans, then they may need to be separated into an armslength SPV (regardless of the fact that Northern Rock didn't have an investment bank). See Blundell-Wignall, Wehinger and Slovik (2009).…”