Why Failure Would Be a Virtue in Banking

It’s time to re-examine support measures and regulations put in place since the financial crisis

By Paul J. Davies




Profitability is still a struggle for many banks, especially outside the U.S.

It isn’t just about high capital requirements, low interest rates or poor investment activity. It is also about overcapacity: there are simply too many banks.

One big reason is that policy makers, perhaps unwittingly, have created barriers to exit, according to the Bank for International Settlements.

Support measures and regulations to protect the financial system that have been put in place since the financial crisis are propping up banks that in normal times would shrink, close down or get bought. Some of these need re-examining.

There are several ways to measure how banking capacity has changed. The number of licensed banks has fallen in both the U.S. and European Union since 2007—by almost 30% in the former but by just 16% to the end of 2015 in the latter, according to the latest data.

This hasn’t necessarily reduced capacity, though. The number of physical branches per 100,000 people has barely changed in the U.S., Japan and much of Europe, according to The World Bank. Spain has had a big decline, but still has far more branches than Italy and twice the number per head of the U.S.

So what is the issue? First, bank mergers and takeovers collapsed after the crisis and haven’t really recovered. In Europe, Mario Draghi, president of the European Central Bank, and Danièle Nouy, Europe’s chief bank regulator, have called for more consolidation. But executives aren’t biting. They are afraid of how regulators will treat them. Any big bank that grows in size and complexity is likely to face higher capital demands. That could hurt returns and limit dividend-paying capacity.

Another way of cutting capacity would be allowing banks to fail. In Europe, that still seems difficult, despite regulatory efforts to make it less so. This is down to political queasiness over enforcing the rules, especially in the weakest markets where failures are most likely, like Italy.

Spain has just forced through the resolution and sale of a failing bank, but Italy is still struggling to find a way around the rules and deal with several stuttering lenders large and small.

Overcapacity is a problem across Europe, more so than the U.S. Regulators can point out this problem. It would be better to start coming up with solutions, too.

Widespread deregulation isn’t the answer, but Europe should move faster to create a true single market for banking—like that in the U.S.. That would help consolidation the most.

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