BoE's Haldane: "Too Big To Fail Is Far From Gone"

Tyler Durden's picture

Authored by Andrew Haldane (Executive Director, Bank of England); originally posted at VoxEU,

Have We Solved 'Too Big To Fail'?


That is not my pessimistic verdict; it is the market’s. Prior to the crisis, the 29 largest global banks benefitted from just over one notch of uplift from the ratings agencies due to expectations of state support. Today, those same global leviathans benefit from around three notches of implied support. Expectations of state support have risen threefold since the crisis began.

This translates into a large implicit subsidy to the world’s biggest banks in the form of lower funding costs and higher profits. Prior to the crisis, this amounted to tens of billions of dollars each year. Today, it is hundreds of billions (Haldane 2012). In other words, if the market’s expectations are to be believed, the regulatory response to the crisis has not plugged the 'too-big-to-fail' sink.

On the face of it, that sounds perplexing. Rarely a day passes without a warning from the financial industry about overbearing regulation of, in particular, the world’s biggest banks. What is certainly true is that, in the light of the crisis, regulation to quell the too-big-to-fail problem has come thick and (at least in regulatory terms) fast. This reform effort falls into roughly three categories:

(a) Systemic surcharges: of additional capital levied on the world’s largest banks according to their size and connectivity. This Pigouvian tax on systemic risk externalities is built on conceptually sound foundations (for example, Brunnermeier 2009). And, encouragingly, good economics has found its way into good public policy. Last year, the Financial Stability Board (FSB) agreed a sliding scale of systemic surcharges for the world’s largest banks. The highest surcharge was set at 2.5% of capital.


Yet therein lies the problem. Based on my estimates (Haldane 2012), a charge levied at this rate would leave the majority of the systemic externalities associated with the world’s biggest banks untouched. The reduction in default probabilities associated with lowering leverage by a percentage point or two would not offset the higher system-wide loss-given-default associated with the world’s largest banks. The systemic tax is being levied at rates which are too low to meet Pigouvian ends.


(b) Resolution regimes: In principle, orderly resolution regimes for banks could lower the collateral costs of a big bank defaulting, thereby tackling at source these systemic externalities. And significant public policy progress has been made on this front, with the FSB publishing (and the G20 approving) some Key Attributes for Effective Resolution Regimes during the course of the past 18 months. A key component of these plans is the ability to impose losses on private creditors – so-called 'bail-in' – rather than have those losses borne by taxpayers.


As with systemic surcharges, the issue here is not to so much the bail-in principle, but its application in practice. Bail-in, whether of big banks, sovereigns or companies, faces an acute time-consistency problem. Policymakers face a trade-off between placing losses on a narrow set of tax-payers today (bail-in) or spreading that risk across a wider set of tax-payers today and tomorrow (bail-out).


A risk-averse, tax-smoothing government may tend towards the latter path – and historically has almost always done so, most notably in response to the present financial crisis. Next time may of course be different. But the market is sceptical. For example, in the US the Dodd-Frank Act on paper rules in future bail-in and rules out future bail-out. Yet market expectations of state support for US banks are higher today than before the crisis struck and are unchanged since Dodd-Frank became law. The time-consistency dilemma, at least in the eyes of markets, is as acute as ever.


(c) Structural reform: One way of lessening that dilemma may be to act on the scale and structure of banking directly. Several recent regulatory reform initiatives have sought to do just that, notably the “Volcker rule” in the US, the 'Vickers proposals' in the UK and, most recently, the 'Liikanen plans' in Europe. While different in detail, each of these proposals shares a common objective: a degree of separation or segregation between investment and commercial banking activities.


In principle, these ringfencing initiatives confer both ex-post (improved resolution) and ex-ante (improved risk management) benefits. Because they act on banking structure, they have a greater chance of proving time-consistent. While this is a clear step forward, those benefits are only as credible as the ringfence itself. The issue raised by some is whether, in practice, the ring-fence could prove permeable. Without care, today’s ring-fence could become tomorrow’s string vest.

If each of these initiatives is necessary but none is individually or collectively sufficient to tackle too-big-to-fail, what is to be done? One solution might lie in strengthening these proposals. For example, re-sizing the capital surcharge, perhaps in line with quantitative estimates of the 'optimal' capital ratio (Miles et al (2012), Admati et al (2011)), would be one option for bearing down further on systemic externalities.

Another more radical option, mooted recently by a number of commentators and policymakers, would be to place size limits on banks, either in relation to the financial system as a whole or, more coherently, relative to GDP (Hoenig (2012), Tarullo (2012)). Proposals of this type typically face two sets of criticism.

The first, practical issue is how to calibrate an appropriate limit. Recent research on the link between and financial depth and growth provides a way into this question. This research has suggested that there is a threshold at which the private-credit-to-GDP ratio may begin to have a negative impact on GDP and, in particular, productivity growth (Arcand et al (2012), Cechetti and Kharroubi (2012)). By taking a view on this aggregate threshold, and on an appropriate degree of concentration within the financial system, an institution-specific threshold could be derived.

The second, empirical issue is whether size limits would erode the economies of scale and scope which might otherwise be associated with big banks. The empirical literature on these economies has, until recently, suggested they may be exhausted at relatively low balance sheet thresholds. But a number of recent papers have painted a more optimistic picture, with economies of scale found for banks with balance sheets in excess of $1 trillion (Wheelock and Wilson (2012), Feng and Serilitis (2009), Hughes and Mester (2011)).

Yet this evidence needs to be interpreted cautiously, not least because it fails to recognise the implicit subsidies associated with too-big-to-fail. These would tend to lower funding costs and boost measured valued-added for the big banks. In other words, the implicit subsidy would show up as economies of scale. Bank of England research has recently shown that, once those subsidies are accounted for, evidence of scale economies for banks with assets in excess of $100 billion tends to disappear (Davies and Tracey (2012)). Indeed, if anything, there may even be evidence of scale diseconomies, perhaps consistent with big banks being 'too big to manage'.

Too-big-to-fail is far from gone. It is even more important it is not forgotten. Further analytical work, weighing the costs and benefits of different structural reform proposals, would help keep memories fresh and policies on the right track.

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LetThemEatRand's picture

"Economies of scale...."  

Is that the new euphemism for outrageous bonuses paid to banking executives whose sole contribution to society is occasionally hiring a hooker and trickling it down?

francis_sawyer's picture

Oh ~ I read it as 'Ecomony of scales' [as in reptiles]... thanks for the clarification...

LetThemEatRand's picture

In both cases the reptiles in question hang out a lot with girls named "Eve," so I think we're both right.

knukles's picture

Shape Shifting Annanuki Reptiles of Sumerian Legend Live Amongst Us

Or you'd think so with this behavior, for Christ's sake


(Please don't whip me no mo massa Reptil, I dig fo da gold, I dig)

trav777's picture

they have to be gigantic to eke out any return, leverage goes to infinity as yield goes to 0.

disabledvet's picture

And the biggest problems (cough, cough London Whale cough, cough) show up in the smallest of places. Amazingly "people still call that stuff a surprise." Not to the City it wasn't. They had Prince Charles reading a weather report just prior to! And of course "the only one who can forecast the weather is a weatherman" right?

knukles's picture

He oughta know what the weathers gonna do... he's a reptil, too.
Gotta warm out in the sun....

kliguy38's picture

I've saved up since the last TBTF bailout and I'm ready to do my patriotic duty for my Banks and sacrifice. After all what would Christmas be without 130Billion in bonuses this year......

TraderTimm's picture

One solution might be to use bitcoin to starve the banking parasites.

I know, money makes you happy and you can't trust something new. That's okay, there will be a need for people to cling to the old system as examples of abject failure.


Half_A_Billion_Hollow_Points's picture

That's going to happen.  Give it time.

CPL's picture

Ah....that's why Carney moved.

knukles's picture

Is a Carey move similar to a Bowel move?

Acet's picture

This being finance we're talking about, they both feel suspiciously similar for anybody below.


rwe2late's picture

So, if they are Too Big To Fail,

our money is safe with them.


... heh heh

WarPony's picture

Isn't that the BIS plan, with a pinch of BASEL? Stewed and slow cooked/reduced to a nice medley of NWO delight.

Ghordius's picture

I don't see much connection between NWO and BIS's BASEL plans

Point in case: most US MegaBanks are saying the BIS can stuck their BASEL III proposals where the sun doesn't shine

legorf's picture

"over one notch of uplift from the ratings agencies"

I can't believe some still listen to what ratings agencies say.

disabledvet's picture

I don't recall Teddy Roosevelt's second term being equity positive. It did of course cement Mr. J P Morgan's legacy as the greatest banker in US history....a reputation that grown exponentially since 2008 I would argue.

davidsmith's picture

This horse is out of the barn.  The bad debts of the banking system are so enormous that nothing can be done now except to see the world economy crumble into depression.  Who is this guy trying to kid?

NoDebt's picture

"The bad debts of the banking system...."

Agreed, except for that point.  I can see no differentiation between TBTF banks and the government.  They are virtually one entity at this point.  The mere listing of TBTF ("systemically important") banks by the government means they are, by definition, part of the government now.

All animals are equal.  Just that some animals are more equal than others.


knowless's picture

so banking entities don't like anti-monopoly legislation, color me fucking pink.


how about we just put in place actual laws, which limit extortion? and as to do with the multiplier effect of scale, that profit is do to the indivual who creates that value, not the one who drops it in a table.


if you want to trade, then do so within the limits of your class. once you pretend that you can "create value" from the top, you destroy the nature of the "economy" and may get in line, over there, for your razor thin "profits".


go fuck yourself.


as long as the farce continues, it will only be worse in the end.

title drops to active owner nigger. not by which the previous legal authority had granted, but yet, to he who occupied.  have fun enforcing your contracts when the real individuals, those with legitamate contracts, no longer just step out of the way.

it's good though. because hey, we all know monetary regimes never end.

knowless's picture

its your entires life take, when they fix that rate.

Whiner's picture

Yak-yak. Talk, talk. Bonus, bonus. These bankstas are walking across a 100 mile quicksand lake and the planks 'fore and aft of them just sunk our oh sight. Bust em' up and sell'em off, restoring Glass-Stegal. Jail half of the execs.

williambanzai7's picture

So free checking is a justification for TBTF moral hazard and oligopolistic mayhem.

groundedkiwi's picture

Too big to Bail is what they should be

Lord Of Finance's picture

"to big to fail has been around since 84."


   . . . and there is a whole lot more to add to that pile of printed paper bailouts. To list them all would take too much time, but you covered the big ones. In the 1980's, the bailouts were in the millions. In the 90's, they were in the billions. In the first decade of the millenium, they were in the trillions. In this next decade they will be in the quadrillions, and then it is game over, re-set, match.


  Our bail out will be in the hard, shiny stuff that the earth provides. All that is man made, will soon enough be laid to waste.

falak pema's picture

Dead right : 1984, awesome date of Orwellian imagination.

When Reaganomics and Thatcherism truly flowered.

NoDebt's picture

Another article talking about ways to "fix" the TBTF banking "problem."  Wasted breath.  Fixing it is not the goal.  Has this point not sunk in yet?

The fat lady of "control" (read: power) has not sung yet.  She's just clearing her throat.


Nobody For President's picture

And much of the 'solution' seems to be "we're going to continue to study this problem, by golly."

Lord Of Finance's picture

Yeah. When the bond market reverses course, the politicians will set up more committees to "investigate" "what went wrong", to eventually come to their already pre-determined conclusion.


  Which of course will be that, "capitalism has failed". 

Hobie's picture

Oprah: Do you want to solve the 'To Big To Fail' problem?

BoE Muppet: No.

Nothing more to see here. Carry on...

falak pema's picture

the TBTF are getting bigger every day...humpty dumpty comes to mind...

"When I use a word," Humty Dumpty said in a rather scornful tone, " it means just what I choose it to mean- neither more nor less."

"The question is," said Alice, "if you can make it to mean many things."

"The question is," said Humpty Dumpty, "which is to be master - thats all."....

Doesn't that perfectly summarise the discussion these days about the CB-TBTF cabal of Squid concoction?

Squid/TBTF/CBs = Humpty Dumpty.

God bless the Alices of this world who question that logic!