Sticking together

SURGERY is an appealingly radical way of dealing with a diseased organ, but it can have a damaging effect on the rest of the body. That’s one reason why separating the investment and commercial wings of large “universal” banks is the wrong way of going about protecting taxpayers from reckless bankers.

The debate about splitting up universal banks has been rumbling since the start of the crisis, when behemoths such as Citigroup and Royal Bank of Scotland (RBS) nearly collapsed, but has reignited recently. Sandy Weill was the man who stitched Citigroup together in the 1990s and in the process helped bury the Glass-Steagall act, a Depression-era law separating retail and investment banking. Last month he performed a perfect pivot: he now wants regulators to undo his previous work. The idea is also on European minds. Wolfgang Schäuble, Germany’s finance minister, says he would “not exclude” a division of this kind. And Vince Cable, Britain’s business secretary, fancies carving up RBS.

Bashers of universal banks have three sticks with which to beat them. The first is based on the idea that there something rotten about investment banking, a cultural miasma that infects the “good” bits of the banks where companies and individuals get loans and place deposits. The second is that they are a threat to financial stability, because universal banks tend to be bigger and more complex than more focused peers. And the third is that universal banks are a dreadful deal for investors. Mr Weill’s former bank has lost 94% of its value in the past five years; RBS is down by a regal 96%.

None of these criticisms, however, would justify a full-scale break-up. The idea that all finance’s problems stem from the investment-banking “casino” is a misdiagnosis. At its heart the crisis was a problem of too much debt, much of it secured against property. It is true that the wholesale markets played an important role in the build-up of this debt, but it was propelled by bad lending to individuals and developers from retail and commercial banks. And with these credit channels now blocked up, investment-banking activities such as helping companies to issue debt and equity are a crucial way of channelling savings to businesses with good ideas.

The stability argument is dubious, too. Because they are diversified, universal banks spread their risks. During the crisis, for example, banks such as JPMorgan Chase saw a sudden slump in investment banking offset by their retail-banking income, and vice versa. Lehman Brothers and Bear Stearns had no such hedge—and imploded. Many firms are now choosing to issue bonds rather than take out bank loans. This means pure retail banks lose out, but those with wholesale arms boost profits by taking firms to the bond market.

The notion that universal banks are worse for shareholders than other banks is also open to question. Poorly as they have performed, they are grabbing market share from pure investment banks in areas such as bonds, currencies and commodities (see article). Finally, though it is easy to call for banks to be carved up, it would be hellishly difficult in practice. Disentangling which shareholders and bondholders should own which bit of a divided bank would be a nightmare.

Better medicine

Change is certainly needed to protect taxpayers from having again to fork out billions to save the banking system from the consequences of its own mistakes. The very size of universal banks makes them dangerous, for they know the state will bail them out if things go bad. But most are so large that simply slicing them in two would not solve the problem. The effect of splitting up banks like Citigroup, RBS and Deutsche Bank, all of which have assets well over $1 trillion, would be to create six systemically important banks instead of three.

More effective medicine is already on offer. The British government is set to adopt the recommendations of an independent commission in Britain, which include the adoption of a “ring fence” that would force the retail and investment-banking arms of universal banks to have their own capital buffers, shielding depositors from losses in the investment bank but retaining some diversification benefits. Add in new rules requiring all types of banks to hold more capital, and (crucially) efforts to impose losses on private creditors of a failing institution, and the case for radical surgery is blunted.