Are Bigger Banks Better?

Charles Calomiris thinks so. He's a professor of finance at Columbia Business School who penned an op-ed in today's Wall Street Journal arguing that efforts to shrink banks are misguided. I happen to be quite apprehensive about the notion of blindly breaking up banks. So I agree with Calomiris to a point, but I'm not entirely convinced by his arguments.

A Resolution Authority

Here's where I agree wholeheartedly with Calomiris:

Governments currently have trouble allowing large, complex financial institutions to enter bankruptcy, or receivership in the case of banks, because there is no orderly means for transferring control of assets and operations, including the completion of complex transactions with many counterparties perhaps in scores of countries via thousands of affiliates. The problem is important to resolve.

I've written a lot on this topic, because I think a resolution authority is utterly necessary. If such an authority is in place and actually can neatly handle a big financial firm's bankruptcy, then I agree that they needn't be broken up. But what if a firm can't develop a resolution plan that wouldn't result in significant harm to the economy?

I think it's important to be sure such failure plans can actually work. If they can't, firms without workable plans need to be broken up into pieces that can be more neatly resolved. I hope that Calomiris would agree with this assertion, but given the rest of his article, I'm not so sure. He continues by providing four reasons why big financial firms are good.

Global Operation

Big banks operate better globally. Sure. But if you broke up banks in thoughtful ways -- particularly if you separated certain business units from each other -- then they would still be able to operate globally. For example, if AIG's property insurance arm was separate from its derivatives operation, then both still could have had a global reach.

Economies Of Scope

Calomiris writes:

Second, there are economies of scope when financial firms combine different products within the same firm (lending and foreign-exchange swaps, for example).

That's true, and it's one of the reasons I'm hesitant about breaking up banks. Yet, I think the question here becomes whether the economies of scope outweigh the dangers of over-complexity and systemic risk. Again, if you can figure out a resolution plan where separate product divisions can coexist, then that's fine. But if you can't, then the economies of scope just aren't worth it.

Customers Benefit

Calomiris argues that consumers and businesses are better off with bigger banks. Here's his basis:

For example, my research shows that from 1980 to 1999, after controlling for changes in the mix of firms, the underwriting costs of accessing the public equity market fell by more than 20%.

Yes, but there was also a lot of technological advance during that time period. So I wonder how much of that 20% is from technology gains. I agree that fuller-service institutions have their benefits for customers, but when you have a sort of oligopoly of big firms that control banking, then consumers and businesses almost certainly suffer.

Increased Market Efficiency

Here, he says that the global markets are more efficient because of bigger firms. That may be true, but I would argue that if global firms focused specific products, that efficiency would be just as high. Technology has also played a role, allowing for advances like faster electronic trades and better information.

In general, I reject the argument that bigger is always better. After all, if it were, then we'd just have monopolies ruling every industry. With that said, I do think that there are reasons why having large firms can result in legitimate economic benefits, as Calomiris indicates. So, really, I don't disagree with his overall point. I think it's okay for firms to become large. What's not okay is when firms become so big and complex that their failure brings down the entire economy. If there's no way to resolve a firm, then it must be broken up. As long as Calomiris agrees that, then I think we're generally on the same page.