ABSTRACTMuch policy disallowed banks from proprietary lending under

ABSTRACTMuch like goliath in Greek myths, it seems big banks have lost their sheen and desirability and face scrutiny in the new global economy.There are debates happening across markets and nations about the viability of breaking down big banks.However is this scrutiny well deserved? How did we end up at this junction, where markets have lost almost all investor confidence? In order to learn from history we must analyze the impact of mega banks on the economy in the past and the possible reforms that exist to deal with them.INTRODUCTIONWhat is a Mega bank?It is essential to understand that a mega bank or a bank considered too big to fail has two elements of size. The first is the simple notion of magnitude of operations. The number of customers they have, the portion of national deposits they hold etc.The second is their nature of operations. Several big banks engage in activities beyond the basic responsibilities of commercial banks. They engage in investment banking as well as other commercial avenues like asset backed securitization, Insurance and trust services.While discussing the idea of breaking down big banks we consider both selling assets of banks to reduce size as well as mandating the sale of their investment banking division etc.Previous legislature Glass Stegal actThis was a policy that restricted commercial bankers from venturing into investment banking. However lobbying efforts by the banking sector led to the repeal of this act. The argument around this was based on the idea that a combined existence allowed banks to diversify risk and provide better services.Volcker RuleThis policy disallowed banks from proprietary lending under it’s own name however they could still participate in the money market for the purposes of market making, underwriting and for their clients.Literature reviewThe wall street journal:It details the consequences of having too big to fail banks in the economySystemically Important or “Too Big to Fail” Financial Institutions Author: Marc Labonte Specialist in Macroeconomic Policy May 26, 2017 It was conducted by the congressional research center and details the benefits of big banksA public citizen’s blueprint for Wall street reformIt details how big banks are too big to manage jail and regulate.ARGUMENTS FOR BREAKING DOWN BIG BANKSSYSTEMIC RISKSWhen a mega bank fails, it has a massive impact on the entire economy. It has deposits that account for more than 10% of the national deposits, all of which are considered in default.Further more due to its liabilities and creditors, bankruptcy of the bank also takes down all these 3rd parties as well due to counterparty risk. Their collapse may lead to a contagion taking down a significant part of the economy.It also depresses public sentiments about banks, and people become averse to depositing money into banks, depriving the economy of crucial capital.BAILOUTSYear200712200820120091202010125201115020127020132502014250201519The following data is the amount of government funds invested in the financial sector by the RBIOn an average that amounts to Mean133Standard deviation89.53351328In order to avoid this calamity government issues bailouts of these big banks financed by taxpayer funds.EXAMPLESOne of the biggest bailouts that occurred in modern history was that of Lehman brothers and subsequently a few other banks at the tail end of the 2008 financial crisis.Another massive bailout was the 1998 bailout of long term capital management whose burden was borne by most united states taxpayers as well as other commercial banksThere are two major issues with Government bailoutsThey enhance moral hazard and they shift the burdens of banks and industry to taxpayers.MORAL HAZARDUsually the notion that bad investments and risky maneuvering can prove to be costly and plunge a firm into losses retards banks from undertaking investments that are considered too volatile. This resistance comes from all the relevant stakeholders in the bank. It includes depositors, management, creditors and counterparties.However a trend of government bailouts allows a perception to be set in that irrespective of what risk a bank undertakes their funds and investment are safe. A government bailout fulfills a banks complete responsibility to account holders and creditors therefore these parties are appreciative of the ideology of higher risks, higher returns.This absence of natural barriers to a banks risk taking leads to erosion of market discipline. Moreover as other banks are capable of promising higher returns, competition pushes banks to choose riskier and riskier return generating avenues.TAXPAYER EXPOSUREThe problem with government bailouts is two fold. One is a simple notion of wasteful allocation of crucial funds and the second is a symbolic idea of burden. Most economies have a paucity of funds. Developing economies have infrastructure needs and an objective of improving citizen’s quality of life. Even western liberal democracies like U.S.A and U.K face problems like eroding social security provisions and an ailing healthcare and education systems.In such scenarios, plunging funds into the financial markets prevents these countries from transitioning into better nations and meeting their developmental goals.Further more, it also represents a failure of government. Governments in order to provide citizens essential facilities, collect tax. Directing these funds in this manner unfairly shifts the burden of financial market operation and regulation onto citizens who have no control over it.FUNDING SUBSIDYOf all the values espoused by a financial market, the most crucial is efficiency.Efficiency entails the best firm and financial product getting the maximum amount of success.Financial products like any other products compete amongst each other. Each bank designs it’s own way of balancing risk and return. The best firm and product get success in the form of maximum customers and access to cheaper funding.However the government bailout policy skews this system in the favor of bigger banks. If lenders know that irrespective of what happens their investment is secure, they agree to provide funds at cheaper rates. These cheaper rates allow TBTF banks to provide higher deposit rates to customers attracting a bigger client base.Therefore a kind of funding subsidy compromises the competition and efficiency of a free market.The following table shows how the scale of assets and deposits relates to credit rating of a companyNAME19 HEADQUARTERS ASSETS20 DEPOSITS21 DEPOSIT SHARE*22 credit ratingJPMorgan New York City $2.4 trillion $1.1 trillion 10%A3Bank of America Charlotte, N.C. $2.2 trillion $1.2 trillion 11%A1Citigroup New York City $1.8 trillion $0.468 trillion 4%A1Wells Fargo San Francisco, Calif. $1.8 trillion $1.1 trillion 11%A2Goldman Sachs New York City $ 0.880 trillion $0.078 trillion 0.70%A1Morgan Stanley New York City $ 0.884 trillion $0.138 trillion 1%A3Total  $9.91 trillion $4.08 trillion 38%ARGUMENTS AGAINST BREAKING DOWN BANKSEconomies of scaleA conventional argument for bigger banks has been economy of scale. As they are capable of dividing fixed costs across greater number of customers, their charges and interests are more conducive for customers.Furthermore their greater access to capital allows them to extract maximum benefit from an opportunity. All these factors allow them to provide greater returns at lower costs. In such a scenario, breaking down big banks will reduce efficiency.Economies of scopeInvesting across different markets and industries allows firms to diversify more and hedge their risks better. This enhances their ability to manage risk and provide consistently higher returns.Public sentimentThe core fact remains that the very process by which a bank acquires a mega status is an argument to keep it like that. When customers choose this bank over others time and again, they make an active choice with regards to their preference in financial services. By breaking down banks and arbitrarily allotting customers to other smaller banks, it violates a customer’s freedom and agency to choose.This may disillusion potential savers from depositing in the banking sector.Research methodologyTo calculate the concentration of deposits as per interest rates. This allows us to evaluate if people are okay with a higher return irrespective of risks involved. If this is true breaking up big banks would go against public sentiment.This is analyzed by using graphs and correlationDataNTEREST RATE RANGE     INDIVIDUALS      OTHERSNo. of AccountsAmountNo. of AccountsAmount1234Less than 6 per cent9.315.517.413.16 per cent and above but less than 8 per cent29.725.929.341.68 per cent and above but less than 9 per cent37.333.633.236.19 per cent and above but less than 10 per cent21.522.218.38.510 per cent and above but less than 11 per cent2.12.61.20.711 per cent and above but less than 12 per cent0.10.20.40.112 per cent and above but less than 13 per cent0.00.00.10.013 per cent and above0.00.00.00.0TOTAL100.0100.0100.0100.014.432.734.716.21.80.10.00.014.4532.7734.7816.261.840.130101Correlation coefficient; – 0.706As the amount of deposits don’t move along with interest rates, the argument against breaking down banks to ensure higher interest rates is not supported by public sentiment Even the correlation coefficient is negative.Furthermore, on a principal level the funding also drives lowered interest, it is a false equivalence to assume as fact that banks have lower interests due to economies of scale.In fact there has been erosion of public confidence that is represented by a comparison of stock value of companies across years.Wells Fargo a bank that did not engage in  derivative trading and restricted it’s size is the only one that faired well Stock price, May 1, 2007 Stock price, February 3, 2016 Citigroup $491 $40 Bank of America $51 $13 JPMorgan $52 $57 Wells Fargo $36 $48 Goldman Sachs $219 $153 Morgan Stanley $84 $24 Dow Jones 13,13616,367SubjectivityThere is considerable subjectivity with regards to what scale and nature of banks can be classified as too big too fail. Such subjectivity paves the way for political agendas and partiality in policy making, undermining its intention.InnovationLastly, big banks have access to a wide range of market instruments and resources that allows them to successfully come up with and execute new innovations. This can be something as basic as ATM’s to complex financial product like trans national interest swaps.ALTERNATIVESCapital Restructuring This is one of the most favorable  alternatives. It involves putting restrictions with regards toMinimum liquidity requirement Minimum owner capitalThis reduces the extent of risk that exists in the operation of the bank, as there is security in the reserves of the bank. Moreover it reduces counter-risk exposure to third parties, as a banks borrowed funds are diluted by their own capital.These special criteria only come into play when a bank meets the threshold of being Too Big To Fail.However bankers may transfer increases costs to the clients charging higher interest rates. This may create deflationary pressure in the economy and people may spend and produce less. This is especially problematic for Developing countries.Dodd Frank PolicyDodd frank policy is a recently developed policy in the United States of America.It requires any new firm that reaches the status of Too Big To Fail, to come up with a contingency plan that assures the policy makers that a collapse of the bank will not lead to contagion in the market. A failure to come up with a satisfactory plan will lead to a break down of the bank. PRINCIPLE ARGUMENTS AGAINST BIG BANKSThere are certain principle objections to Big Banks as well.Namely They reduce the competition in the banking industry.  Due to mergers and acquisitions, the banking sector has become more and more concentrated. This reduced competition means banks are less incentivized to provide better services. However this concern is far fetched and mostly theoreticalBig banks also distort public policy and the process by which it is made. Many of these large banks make significant contributions to political candidates when they run for elections. This conflict of interest skews policy making unfairly in the favor of these big banks. Furthermore their ability to organize themselves into formal lobbying organizations and their influence in the overall economy makes the situation worse.ConclusionTo conclude we can state that both principle and structural arguments support the breaking up the banks. There are certain benefits of big banks and alternatives to breaking up but these mostly leave out the principle issues.Under scope for further research we may consider the impact of breaking down banks in a single economy when too big to fail banks continue to exist abroad.