Last four decades have witnessed the fastest growth of the global financial market. The finance industry all over the world has gone through rapid expansion during this period. Worldwide monetary network, connectivity, service/product diversity and investment structure have been established. Globalisation and the slogan of turning the world into a global village have expedited this process. During this period, banking services have come out of its core product of deposit taking and sanctioning loan.
Many new sophisticated financial products have been introduced in the market which has brought about a new dimension in the world financial industry. At the same time, tremendous technological development has taken place in the banking industry and banks had to make huge investment in technology. Because of technological advantage, banks have been able to offer online banking, 24-hour banking, mobile banking, internet-based trading platform and many other forms of services, which have brought mass people under the banking network. Even the volume of transaction as well as its frequency has increased manifold.
On the other hand, the world economy has developed rapidly and even the economies of many developing and least developed countries (LDCs) have achieved phenomenal development. As a result, people's income and ability as well as propensity to save have also increased considerably thus technically encouraging them to diversify their investment matching with various risk appetite. This ample opportunity has been efficiently capitalised by the banking industry. With all of these spectacular developments, the financial industry has persistently grown all over the world during the last 40 years. However, the growth rate was not equitable for all banks as some have grown enormously with faster pace while others have grown very slowly. Consequently, a kind of polarisation has taken place in the world financial industry because the lion share of financial assets has gone into the grip of a few handful banks.
To speak the truth, a disguised form of oligopolistic financial market has been created in the world financial industry. In consequence of this development, definition of banks has started changing as the classification of big banks, medium banks and small banks has surfaced. Even in many cases, the bank has been defined as a financial institution because many banks have largely widened its business periphery. All kinds of financial or transactional needs of people ranging from teller service to real estate trading to funeral insurance have been brought under one umbrella of banks which are commonly called investment institutions.
BANKS AND BUSINESS ENTITIES: In order to provide all types of financial services, banks have established various business entities in the name of subsidiary, associate, parent company, offshore operation, onshore operation etc. and therefore, the establishment has turned into group viz. HSBC Group, Citi Group, Deutsche Bank Group, Santander Group, UBS Group etc. By way of establishing a mammoth financial establishment, each big bank has started enjoying unilateral competitive edge over all other medium and small banks or financial institutions. Customer confidence and market advantage have always been in their favour and even other banks or financial institutions have to substantially depend on these few big banks for providing services to their customers particularly related to trade finance services, cross-border transaction, remittance services, maintaining nostro as well as settlement account. Moreover, patronisation from the government policymakers and regulators had been fuelling the establishment of some big banks in the world financial industry. In fact, recession in early 1990s and 'dotcom bubble' was managed and survived with the help of the financial industry, particularly the role of large banks which subsequently established the concept 'Too big to fail' in the developed world. Having been encouraged by this motto, the government policymakers and regulators have extended policy and logistic supports paving the way for establishing big banks since 1990.
BIG BANK AND ITS GROWTH: It is very difficult to find out any recognised definition of a big bank but many financial analysts, experts and international reports have always categorised three different types of banks solely based on their asset volume. Banks having assets more than US$ 1.0 trillion is termed as big banks while banks having assets value between $50 billion to $ 1.0 trillion are considered as medium banks and the rest i.e. those which have assets less than $50 billion are termed as small banks. Big banks are very few and among them JP Morgan Chase Bank, Citibank NA, Bank of America, HSBC Bank, Barclay's Bank Plc, Royal Bank of Scotland, Deutsche Bank AG, UBS and Credit Suisse are prominent. During the last 25 years i.e. prior to the beginning of financial meltdown in 2008 with the collapse of Lehman Brothers in the United States, these big banks have registered enormous growth. In 1990, all big banks possessed assets of $ 3.6 trillion which was equal to 16 per cent of the then world GDP (gross domestic product). In 2008 and 2009, total assets held by big banks accumulated to $ 25 trillion and $ 26 trillion which are equal to 40 per cent and 35 per cent of the world GDP respectively. Apart from this, the Financial Stability Board (FSB), a global group of regulators, have also termed 30 banks as globally important banks which also enjoy the status of big bank.
SUDDEN BLOW: When big banks had been doing brisk business in the financial industry generating billion dollar revenue every year, a sudden blow came with the outbreak of economic recession allegedly caused by financial turmoil which started with sub-prime scandal in the US and rapidly contaminated the world, particularly the developed economies. Lehman Brothers collapsed and was followed by some other banks. Existence of some big banks was at stake calling for financial assistance in the name of so-called bail-out package from the government for its survival. The magnitude of crises was so immense that the government, politicians, policymakers and, above all, regulators were bewildered and did not have enough time to make deliberation but to jump with solution in order to protect the big banks which would eventually help the economies survive.
Needless to say, recession which started in 2008 was very unique in nature and quite different from all the previous recessions. Previously, economies fell into recession where business enterprises had been suffering and banks or financial institutions came up with the help to rescue and after the end of recessionary cycle, the economies revamped. But in the 2008 recession, the banks and the financial sector were the epicentre of troubles. Creation of financial hybrid products, sub-prime mortgage scandal, mismanagement of banks and financial institutions, among others, were the root causes of the recession. As a result, there was none except the government to come forward with helping package for survival of the banks. The concept of 'Too big to fail' eventually proved wrong and the new concept 'Too big to control' came up. In this changing scenario, the government, policymakers and regulators started to rethink about the control and management of big banks. The banks were so big and heavily dependent on technology that quality control was very difficult to be put in place. Technology may not always ensure qualitative judgment; quality and quantity cannot go together after a certain level.
DODD FRANK ACT: Technology will always say two and two make four which is true but two cokes and two bottles of milk will not serve the purpose of four and therefore human quality and prudence are inevitably required to make true judgment. At the same time, profit was the only driving force and many blue-eyed boys were recruited with high target of revenue and in order to achieve this skyrocketing target, many financial engineering or disguised manipulation was started by way of creating various hybrid financial products. Since the banks became very big with complex organisational structure and cumbersome reporting lines, there were many loopholes in control mechanism which were unable to detect or prevent many compliance failures.
In order to protect the big banks, the government had to pour taxpayers' money in the name of bail-out package but at the same time, an anatomy of this failure was also conducted and many important issues came up. The authorities subsequently realised that no bank can be so big that it will not fail. At the same time, they also realised that big bank is not always good from control perspective because it cannot be controlled easily. The authorities then contemplated to initiate measures of either splitting the large institutions into some small separate entities or downsizing the companies as a whole.
But direct intervention seemed to be very difficult as the critics and many stakeholders argued that this action was absolutely contrary to the free market norms. In this situation, the government, policymakers, and regulators resorted to indirect measures by making the relevant rules and regulations more stringent for the big banks in particular. As a part of the first measure, discriminatory core capital requirement was put into place for big banks. In general, the requirement of minimum core capital for all banks is 7.0 per cent of its risk weighted assets which has been set at 9.50 per cent by FSB (Financial Service Board) for big banks like JPMorgan Chase Bank and HSBC. The US regulators have added further 2.0 per cent higher ratio for capital requirement of big banks like JPMorgan Chase and this 11.50 per cent ratio will have to be complied with by the year 2019.
In addition, the US government has enacted the Dodd Frank Act which came into force in 2015 and this law has banned banks from their proprietary business. Under proprietary business, banks were allowed to make their own investment instead of their customers. Prior to the recession in 2008, this proprietary business was very attractive revenue-generating window of banks and all big banks had conducted enormous business with their own funds by means of creating various hedge funds in the name of its subsidiary and thereby generated huge profit. Creation of hybrid financial instrument like sub-prime mortgage was the result of banks' proprietary business and this was held as one of the main reasons behind financial meltdown in the US and elsewhere in the world. With the enforcement of the Dodd Frank Act, banks will not be able to conduct their proprietary business anymore which will, of course, have negative impact on their revenue and growth as a whole. [The concluding part of the article will appear on Tuesday, February 23.]
The writer is a banker based in Toronto, Canada.