Wednesday, 3 July 2013

Parliamentary Commission on Banking Standards ponders TBTF.

I like the opening remarks at this hearing of the above commission.
Andrew Tyrie (chair) asks Mervyn King whether he agrees that “the elephant in the room is that banks are still too big to fail? Have you now got the tools that you need to deal with that?”
Mervyn King replies: “If I were to say what the objective is over the next five to 10 years for the Prudential Regulation Authority, it would be to ensure that, at the end of that period, we have genuinely solved the "too big to fail" problem.”
10 years eh? No great sense of urgency then.
I mean the Vickers commission has come and gone, and they were supposed to solve the TBTF subsidy problem, or at least reduce the extent of the problem. So what progress? Well according to this article by Andrew Haldane the TBTF subsidy is bigger than ever! I.e. the “progress” has been negative.
And in the US, there has been the same failure to deal with TBTF – see first two paragraphs here.

The TBTF problem has been solved!!!!
Anyway, I have good news. There is a system that solves the TBTF problem, and several other banking problems at the same time.
The solution is set out here. Much the same solution is set out here.
The only apparent drawback with those solutions is that they involve depositors who want their bank to lend on their money to take a hair-cut if and when those loans go wrong. I.e. depositors in effect become shareholders in their bank. And that might seem to involve a rise in bank funding costs.
Well the answer to that criticism was given by Messers Miller and Modigliani: raising the proportion of bank creditors who are shareholders has no effect on bank funding costs.


  1. It is a fantasy to believe that raisng the equity component of bank financing won't impact the cost of banks funding. MM implies rational behaviour of investors as well as an absemnce of taxation, both of which impact banks. Bank equity is priced by professional investors, whereas the majority of bank debt funding in the form of deposits is determined by irrational consumers. Deposit rates have come down in the UK by over 1% this year and yet we aren't seeing a wholesale move of deposit to other forms of investments - irrational behaviour. Assuming you can replace that funding with equity and the market will adjust the cost of equity such that it meets the current WACCs of the banks is laughable. Secondly the taxation impact is crucial. A deposit at 4% is an effective 3% after tax cost to the bank, so you would have to assume that investor were prepared to accept a return on equity below what debt pays in order for the bank to match it funding cost in an all equity capital strucutre. Again, total immpossible.

    1. Quite right. I overstated my case by saying there would be “no effect on bank funding costs”. Bank funding costs WOULD RISE, but I suggest only to the extent that a subsidy is being removed. So that rise in funding costs is wholly acceptable and indeed beneficial.


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