07 Dec 09 Sustainability in Financial Services – Does size matter?

US Treasury Secretary Timothy Geithner has proposed that the Governments should interfere to ensure that financial institutions should never be allowed to grow so big that their failure can attract serious repercussions for the economy at large.

There have been mixed reactions to this proposal. Part of the business community believes that this is a firm step ahead from the Obama administraton, re-affirming commitment to the causes espoused during the presidential campaign and a serious attempt to thwart greed in Corporate America. However, there has certainly been uproar from the business community, especially banks, who have been at the centre of the financial storm.

Among the strongest voices raised against the proposal has been Jamie Dimon’s (The chairman and chief executive of JP Morgan Chase) and among the strongest voices supporting the proposal is Alan Greenspan’s which says “If they are too big to fail they are too big”!

With JPMC’s ~220,000 employees and US $2 trillion in assets, Jamie Dimon has something to worry about. In a strongly worded open-editorial in the Washington Post, Jamie Dimon argues that no company can be too big to fail and as a corollary possibly, every firm should be allowed to fail, if circumstances deem it so.

He argues that the proposal to contain growth will not only ultimately make US banks non – competitive but would also leave the customer ill- served. Size brings with it many advantages to a customer and artificially containing size will prove counter productive. Needless to say, Dimon’s editorial has led to another round of debate.

The developments in the US led me to think about issues closer home. When the UTI fiasco happened, the Government ultimately bailed it out of the mess. What would happen, if SBI or (horrors!) LIC should fail? You bet the government would step in –  it simply has no other choice.

So when we talk of all things sustainable, should Corporate Growth figure in it as well? The question is a good one and I believe that intentions from both sides are good as well.

I do think it would be impossible to insulate the economy if the biggest institutions that have more than 10% of the country’s deposits fail one fine day. JPMC (and the other big four of earlier eras) have given similar free market arguments, “investor and economy benefits” arguments.  It may  also be worthwhile to analyze some of the claims by Jamie Dimon and other big banks – whether incremental size really delivers measurable benefits to customers? Will there always be benefits in increasing size to infinity or whether at some point it becomes a burden and raises administrative costs and challenges (forgetting the risk for a moment).

But on the other hand, a proposal like Geithner’s would at some level question the very fundamental basis on which every business is run –  to parody a key accounting concept, the “growing concern” basis. Further, even if banks do manage to “shrink and separate” on paper, you can be sure that there will be room enough to manoeuvre control from the back door.

If not explicit caps on size, I think there should be enough disincentive created for incremental size or business to control the risk.  Yes, no one can predict black swans – if we could, we wouldn’t let them swim around. But if there is anything that can be done to minimize the effects of their occurrence, lets do it. Maybe Dimon’s expanded resolution authority could be the answer after all!

PS: and now comes the news that Jamie Dimon is being discussed as a potential successor to Tim Geithner!

Pratibha Kurnool

Pratibha was part of the ValueNotes solutions team, creating and designing business proposals and business propositions.

  • Aamod
    Posted at 11:51h, 13 January Reply

    There are examples where a firm has been forced to split, typically to keep the competition alive. Many mergers are routinely struck down by regulators for the same reason. Banking does not need to be any different. With 3 banks cornering 35% or more of the deposits in US, certainly they can decide the rules of the game – it will definitely not be power to the customer. They have already done many policy changes which do not help the customer – the interest rates and penalties on credit cards for example. Market share means power means high charges means big profits means juicy bonuses. I have read Jamie Dimon’s article. Well written, but it is time to call the bluff.
    At the same time, how to control the risk and monopolistic practices is a question without an easy answer. Easy to say too big to fail, not so easy to say what is too big, as rightly pointed out here. Perhaps there should increasing disincentive – through taxes or whatever – as the size grows and the market will automatically find an optimum. Adjust the levers and the optimum will shift.
    Easier said than done of course.
    Good article, thought provoking.

    • Pratibha
      Posted at 11:48h, 19 January Reply

      Thanks Aamod for your views and comments. I am glad you like the article. I think the issue, irrespective of sector or socio-economic impact, remains one of finding the optimum size and the solutions invariably tend to mimic cyclical patterns – I agree theorizing is “Easier said than done” 🙂

  • Cynical Indian
    Posted at 05:54h, 13 January Reply

    Nice analysis and summary.
    There is plenty to fight for on both sides. And as usual, banks will not let go easily. They have a long history of weaving an impressive tale of customer interest to defend anything that makes moolah for the executives, even if it risks the future of the bank itself. investment Banks have refined this skill to an art form. So the tradition of IB chiefs becoming treasury secretaries is bad. Obama knows so i hope the news that Dimon might succeed Gaithner is just a romor. coming back to the argument, although there is a case for controling the size of an individual institution – for both increasing competition and reducing risk – setting an arbitrary limit will not help. It needs to be less explicit but equally effective and done in a way that forces the banks to follow it in letter and spirit.

    Nice blog, looking forward for more. You can never be too cycnical while analyzing the investment banks’ behavior. What we know in public domain is only a tip of the iceberg…

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