In the aftermath of the 2008 crisis, the world was wondering how we ended up with oversized banks that could disproportionately affect the whole financial system and the broader economy.
More than a decade later, have Europe’s banks become too big to fail?
Large banks in the region hold more than 70% of all banking assets and have an average size of almost €700bn, more than 50 times that of medium-sized banks, says Finance Watch, citing the European Central Bank’s consolidated banking statistics. The share of total assets retained by the biggest banks dropped after the 2008 financial crisis, but has since followed an upward trend.
Which raises the question: what is the optimal bank size? This is something that might seem too theoretical to answer during good times, but which suddenly becomes more relevant after troubles have been exposed.
Worldwide, conventional wisdom suggests bigger is better. “Consolidation in the banking sector continues helping to reduce overcapacity and aiming to enhance profitability,” reads a factsheet by the European Banking Federation.
Policy-makers are opposed to limiting increases in bank size, worried it might reduce the potential for efficiency gains in the banking system and harm real economic growth indirectly.
Bigger institutions are also needed in the face of increasing investment in technology and digitalisation, the narrative goes. However, while larger companies may have more funds and capacity to set aside for investments, this does not in itself translate into additional investment.
Economies of scale might end up being modest, a 2014 paper from the IMF found. The value of the economies derived from the presence of large banks is $16bn to $45bn per year for the US banking system, or 0.2% of the US banking system size, and small in comparison to the estimated $6tn to $12tn cost of the recent financial crisis, the paper calculates.
Large banks are also found to create the most systemic risk in today’s financial system, although rules regarding capital requirements, banks’ involvement in market-based activities and funding structure can mitigate systemic risk.
