Would A Single Financial System Regulator Encourage Consolidation?

Over on Seeking Alpha, there's a blog post by Rahul Prabhakar raising the question of what a single systemic risk regulator might mean for financial services consolidation. The question was brought about through a recent statement by Federal Deposit Insurance Corporation Chairwoman Shiela Bair. She hates the idea of the Fed taking over as the sole systemic risk regulator for financial services firms. So do I. One reason she thinks it's a bad idea appears to be that she thinks this will increase consolidation. That would seem to get the ball rolling in the wrong direction, since too many firms have already grown too large, and consequently have been deemed too big to fail. I think that this is a legitimate worry.

First, here was Bair's comment, as quoted by Prabhakar:

This [creation of a super-regulator] would generate more consolidation in the banking industry at a time when we need to reduce our reliance on large financial institutions and put an end to the idea that certain banks are too big to fail.

Prabhakar next analyzes if/why a single bank regulator might encourage consolidation. He doesn't think it necessarily would:

It is unclear why a single-market firm (bank) would acquire another firm (securities or insurance firm) because of regulation. Unless consolidated supervision somehow meant fewer new rules the firm would have to face, why would it want to increase its compliance costs by adhering to more rules? It would just have to hire additional in-house staff, hire more lawyers and consultants, pay higher fees, and face stronger scrutiny because it will be viewed as more systemically-important than single-market firms. The only firms that should prefer consolidated supervision are existing conglomerates. The single-market firm might go ahead with the acquisition, anyway, because the potential profits are higher. But, it's not clear that a consolidated supervisor makes those potential profits easier to achieve.

He eventually concludes that, really, profit is the only motive for consolidation. I agree. If a firm thinks a merger or acquisition will bring higher profits, probably through synergies, then consolidation will occur. Regulation shouldn't play a large part in that calculus. Except for one way, which Prabhakar notes:

Wall Street should prefer the creation of a consolidated supervisor--an easier target for lobbying and appeals than our presently fragmented structure. If faced with lower compliance costs because of consolidated supervision, conglomerates would probably be more interested than otherwise in acquiring single-market firms--which, if unchecked, could lead to the too-big-to-fail nightmare regulatory reform should avoid.

Right. A streamlined regulatory scheme might create cost synergies. Still, I suspect that this might not be what Bair is most worried about.

Instead, I think she worries more about the Fed in particular as the choice for the supervisor. As I've noted in the past, the Fed is not particularly unbiased when it comes to banking. Its charge is really to keep big banks alive. Reform is only a secondary concern.

Would consolidation occur under the Fed's watch? Well, it already has. Just ask Bear Sterns, Wachovia, Merrill Lynch or Washington Mutual. The Fed's answer to big banks' problems was to coerce assist even bigger banks in acquiring them.

The biggest banks are even bigger after the crisis in terms of market share. Consequently, the crisis has exacerbated the too big to fail problem, instead of bringing reform. Maybe Bair figures the Fed will continue to behave in this manner when faced with bank trouble, rather than take strides to preemptively eliminate risk factors that could lead to failure. I think that's probably a legitimate concern.