Many have blamed the problems in the financial system on the fact that banks have simply become too big. However, the size of banks really becomes a concern when they have the potential to lose a high proportion of national GDP. This appears to be more of an issue in Europe as opposed to the United States.
Nonetheless, large banks have be key to faciliatating growth in both developed and emerging markets through the financing of growth for corporate customers, while also assisting savers and investors from around the world.
Not only has the existence of large and well capitalized banks helped reduce costs for consumers, J.P.Morgan notes that the diversification of many of these institutions has also helped to create stability and continuity by providing private rather than public sector solutions to the resolution of distressed institutions.
“We believe big banks should be allowed to fail,” J.P.Morgan said in a new report. “We think stability in the financial system should be addressed by ensuring deposit insurance systems are stable and well funded, and by tackling directly the risks presented by the interconnectivity and potential contagion of the modern global banking system.”
The firm said this is best achieved by regulating higher capital and liquidity ratios, which serves to strengthen financial institutions and make them less likely to encounter stress in the first place. It also said this can be done by legislating a clear recovery and resolution process that provides options at times of distress and by encouraging the creation of sufficient pools of emergency liquidity funding as a backstop to the wholesale markets.
The analysts said regulators should avoid solutions that focus solely on size and scale, and prioritize changes to target those most directly responsible for failure – leverage, poor underwriting and risk management, and an over-reliance on shorter duration wholesale funding.
“The risk of moving from under regulation to over regulation is not one that should be taken lightly,” J.P.Morgan said. “The risk of failure has to be reduced – but this needs to be balanced with the cost to economic growth.”