The towers grow taller but the banks get smaller.

Photographer: Simon Dawson

Shrink, Don't Split, Big Banks

Mark Gilbert is a Bloomberg View columnist and writes editorials on economics, finance and politics. He was London bureau chief for Bloomberg News and is the author of “Complicit: How Greed and Collusion Made the Credit Crisis Unstoppable.”
Read More.
a | A

Some of the world's biggest banks are starting to acknowledge that size isn't everything. It's a welcome development in the effort to solve the "too big to fail" problem, which thus far has been far too focused on the final pair of words as a potential solution (seeking to avert failure by concentrating on capital buffers), rather than the first two words (eliminating systemic risk by making the banks smaller). It's also proof that regulators are succeeding in nudging the world of finance toward a better place.

Leading the way is Royal Bank of Scotland, which hasn't made a profit since 2007 and remains a ward of the state after a $70 billion bailout more than six years ago left it 80 percent owned by the U.K. government. The size of the RBS rescue reflects the sprawling institution it was then; now, the bank is "no longer chasing global market share," according to Chief Executive Officer Ross McEwan.

Too Big to Fail

Yesterday, he revealed plans to slash the bank's geographic footprint, abandoning businesses in 25 countries including China, India and Thailand to leave it operating in just 13 nations. RBS will make "significant" job cuts at its investment bank, which employs something like 18,000 people, and will halve the staff at its U.S. trading division to leave about 1,000 employees there.

JPMorgan Chase, the world's biggest investment bank, is also going on a diet. Daniel Pinto, who runs its corporate and investment business, said this week that new capital rules may prompt it to cut back on interest-rate trading and the prime brokerage businesses that services hedge-fund managers; it's also closing branches in its consumer unit as it tries to shave off $2 billion in costs by 2017. And HSBC, Europe's biggest bank by market capitalization, said this week it will consider "extreme solutions" for divisions that can't generate sufficient returns on capital as part of a "journey to simplify the firm."  

Both JPMorgan and HSBC are displaying enlightened self-interest. Analysts have deemed both to be candidates for a break-up, either by investors who want to unlock perceived value in splitting retail entirely from investment banking, or by regulators who see the two functions as incompatible. Slimming down is a way of addressing the allegation that they're too big to manage without executives having to oversee the total dismantling of their own train sets. HSBC Chief Executive Officer Stuart Gulliver, whose institution operates in 74 countries, has 52 million clients and employs more than a quarter of a million staff, conceded this week that the bad behavior that's cost the bank billions of dollars in fines and compensation is almost impossible to stamp out in such an enormous operation:

It seems to me that we are holding large corporations to higher standards than the military, the church or civil service. Can I know what every one of 257,000 people is doing? Clearly I can’t.

A key measure of how much banks are shrinking is the scale of the reduction in their risk-weighted assets, which is broadly akin to a manufacturer slashing its inventory. Figures compiled by Jonathan Tyce and Arjun Bowry at Bloomberg Intelligence illustrate the contraction at three of Europe's biggest institutions:

There is at least one caveat. Smaller bank balance sheets and a reduced appetite for risk-taking mean any sell-off in the bond market might leave investors struggling to offload their investments. Average daily trading in U.S. investment-grade corporate bonds has increased by just 10 percent since 2009, even as the size of the market almost doubled; RBS estimates that European corporate bond trading has dropped by about 70 percent since 2008.

Nevertheless, smaller banks are a welcome consequence of regulators tweaking the rules on capital to make some risky activities too expensive to be profitable. While we won't know for sure whether the too big to fail issue has been resolved until a large institution goes bust, the financial industry is at least moving in the right direction.

To contact the author on this story:
Mark Gilbert at magilbert@bloomberg.net

To contact the editor on this story:
Cameron Abadi at cabadi2@bloomberg.net