Management theorists, such as Michael Porter and Gary Hamel, have long argued that 'excellent' firms can only succeed by concentrating on their 'core competences' and that firms often come a cropper whenever they attempt to move outside their competitive strengths.
So why do banks believe that they can succeed in selling an increasingly eclectic range of complex financial products to a very diverse customer base in different countries and cultures.
It is often forgotten that the concept of the 'Universal bank', often called the 'Financial Supermarket', or 'BancAssurance' in Europe, is relatively new. In Germany and Switzerland, large banks such as Deutsche and UBS have provided a wide range of financial services to their customers since the mid 20 th century. But in the USA, the 'universal' concept only become banking orthodoxy after the repeal of the Glass Steagall Act a mere ten years ago, in 1999. In Europe, consolidation of financial services across the continent has been driven by the introduction of the 'Single Euro Currency' interestingly in 1999 also. We have had a mere decade of experience in one-size fits all universal banking, and its track record has been far from stellar?
The point is not whether some Universal banks have become too big to fail (the answer is obviously yes, because governments have been loath to let them go under) but the real question is 'Have some banks become too big to succeed?'
The main argument in favour of banks growing big is that larger firms have the potential to become more efficient.
At regards technology, big is undoubtedly better. A large regional retail bank can acquire smaller rivals and by integrating both sets of customers onto a single banking platform they can simultaneously decrease costs and increase customer choice with a wider range of products. This for example is how NCNB, a relatively small bank in North Carolina, grew by aggressive acquisition over 25 years to take over the venerable Bank of America and become the largest US bank by assets.
Likewise, funds (increasingly called wealth) management is a business, in which scale can bring efficiencies, since, up to a certain market share, an investment decision is not dependent on size, the bigger the trade the less transaction cost overhead.
There is also a geographic argument for increasing concentration of banking services, as firms and customers in emerging economies can benefit from experience gained in more mature markets, often achieved by local acquisition. This is why we have truly global banks such as ING and Citigroup.
There are, however, few efficiencies to be gained from combining very different financial services. Other than sharing management there is little benefit, for example, in integrating a retail banking business with a Mergers & Acquisition function. As regards funding, M&A will raise capital not through retail savings but thorough wholesale markets. Even branding will be very different as a large energy firm seeking billions to exploit a new gas field is unlikely to be swayed by advertising aimed at retail customers. Even where the customer segment is the same, such as insurance, there is no reason to believe that an expert is derivatives trading will be able to provide more efficient life insurance than a specialist insurer, even if they have a large retail sales arm.
The efficiency argument in favour of universal banking only holds water if reducing transaction expenses in one area does not increase costs elsewhere.
Where could costs increase in a universal bank?
Risk is one area, as the Global Financial Crisis (GFC) has demonstrated, where costs have increased considerably, arguably because of the growth of diversity in banking.
Financial history is littered with case studies where boards of universal banks have been blind-sided by huge, but unrecognized, risks that have been taken by small units of their business. For example, the recent problems that UBS has experienced with US tax authorities resulting from problems in its 'private clients' business shows that even the most mature universal bank can run into serious trouble. Likewise, Societe General lost billions, in the Jerome Kerviel affair, not in its core banking franchise but in the relatively small equity arbitrage business. Nor is it only banks. AIG, once a byword for excellence in re-insurance, is now a laughing stock because of massive losses due to excess risks taken by a small derivatives unit in London. In all of these cases, valuable capital built up over time through increased transaction fees was lost precipitously due to un-or badly- managed risks.
If universal banks do not increase overall capital efficiency in the economy what purposes do they serve? If these institutions did not have to be bailed out by taxpayers, the question would be largely irrelevant, a matter for shareholders only.
But if they are too big to fail, politicians must ask themselves are the largest banks also too big to succeed?
If they answer is Yes, then there are two courses of action. One option is to break these gigantic firms up letting them re-merge, if necessary, along the lines of product/customer segments where they have expertise and risk management capability.
The other option is to change the principles of corporate governance for financial institutions. Why is it that, when a new business is acquired, regulators and shareholders do not demand that the size of the board is increased correspondingly? Why is it assumed that a board, consisting often of the great and good of the legal and finance fraternity, with expertise of one financial market should be able automatically to come to terms with a completely different set of financial markets and associated risks? It is immature to make such assumptions in theory and unfortunately has proved very costly in practice.
At best, universal banking is a hypothesis that remains to be proven, although contrary evidence is mounting. At worst, universal banking is an experiment funded by unwitting taxpayers that should be terminated immediately before more damage is done. Rather than trying to fix a broken system (until that is it breaks next time) politicians and regulators should look to restructure the banking industry into one that has a decent shot at working, at least from a risk management perspective.
Mark Twain's quipped that 'All you need is ignorance and confidence, and success is sure'. Universal bankers have surely demonstrated success at least in terms of the excesses of their own remuneration but it is the taxpayer that has borne the costs of their stupefying ignorance and unwarranted confidence.
