Thursday, October 1, 2009
"Big banks' risks to the system increase more than proportionately with their size, and these financial giants should pay higher taxes to offset their potential threats to the system, a new study by the Bank for International Settlements says. ... The report, which studied 20 unnamed large banks, also concludes that no single factor can be relied upon to measure the systemic importance of an individual financial institution, and highlights the fact that banks don't need to be large to be systemic. 'A key result is that the contribution of an institution to systemwide risk generally increases more than proportionately with its size,' the paper's authors said. ... In addition, the paper argued that larger institutions should have tighter regulatory standards, by the same reasoning", my emphasis, Natasha Brereton at the WSJ, 14 September 2009, link: http://online.wsj.com/article/SB125287692722706847.html.
This makes no sense. Why should larger financial institutions be riskier? If true, they will have higher capital costs and should shrink to reduce them. Suppose Citibank gets risker as it gets larger. It need not break up to achieve "economies of scale" by getting smaller. Why? The risk is in the assets. It is independent of who owns the assets. All Citibank need do is become a "holding company" of "mini-Citis" Think about it. What's going on here? Bigger financial institutions engage in different activities than smaller ones. That's where the risk comes from, not size. Believe it or not, we covered this issue in George Stigler's Industrial Organization course at Chicago. By the way Vikram Pandit, if Citi paid you $165 million, this idea is worth $1.65 billion. Expect my bill in the morning.