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Banks: small is beautiful (because it allows competition)

There is an odd situation in Unites States. At the end of 2009, the top 20 banking firms, according to Thomas Hoenig, the president of the Federal Reserve Bank of Kansas City, had a common equity (the Tier 1) equal to 5,1 percent of their assets. Other banking institutions held instead 6,7% equity. “If the top 20 firms held the same equity capital levels as other smaller banking institutions, they would require $210 billion in new equity or reduced assets of over $3 trillion, or some combination of both”, said Hoenig in a speech at the U.S. Chamber of Commerce of Washington. The reason is straightforward: the U.S. laws protect banks too-big-too-fail, which become less prudent. The Federal Deposit Insurance Corporation has some limits in protecting failing banks but can make an exception for large institution whose failure might pose a threat to the economy or to financial stability, Hoenig explained. This is a perverse incentive, for a banking corporation, to grow and grow, in order to attain “too-big-to fail” dimensions.

“Larger and more complex institutions have become more difficult to regulate and supervise”, and they have gone off track, meanwhile in 2009 the “45 percent of banks with assets under $1 billion increased their business lending” because they are more solid than larger corporations. However the issue at stake is not the size per se but the level of competition: “If we stray for our core principles of fairness or ignore the rule of law, we distort the playing field and inevitably cultivate a crisis. When the markets are no longer competitive, firms become a monopoly or an oligopoly and it matters more who you know that what you know. Then, the economy loses its ability to innovate and succeed. When the market perceives an unfair advantage of some over others, the very foundation of the economic system is compromised”, said Hoenig. What happened in U.S., maybe in the whole word, was “the formation of a powerful group of financial firms. We have inadvertently granted them implied guarantees and favors, and we have suffered the consequences”.