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The Societal Benefit of Universal Banks & The Evolution of Financial Regulations

picture of banks in Singapore

picture of banks in Singapore


The core of the matter is whether universal banks (UB) have delivered what they were created for – to provide discipline to corporate management, allow for economies of scale (EoS), and promote risk diversification. Regarding societal welfare, it is arguable that specialised banks (SB) are more beneficial.

UBs have failed to provide management discipline. In the melding of different divisions into one entity, the complexities of UBs have often led to oversights in regulations, causing difficulties in managing compliance. It is one of the main reasons why a bank like Lehman Brothers collapsed; and why new regulations like MiFiD II are being imposed. It is also arguable that there is an accumulation, rather than a diversification of risk. The JPMorgan-Enron scandal for example, could have been a by-product of excessive risk taking from the “too big to fail” mentality of UBs, on top of ill-discipline conduct.

Another issue is performance and EoS, which UBs have not proven to have achieved. The average ROE for the UBs in Q2 2017 was 9.75%, lower than before 2007 when average ROE was in double digits, such as 16.29% in 2000. This shows the inability of universal banks to reconcile the mounting costs of management and regulations, unlike SBs such as Lazard and Evercore, which have achieved ROEs over 36% and 25% respectively in Q3 2017. While UBs do provide ‘all-in-one’ convenience, it is undeniable that their complex structures have impeded their ability to provide cost efficiency and superior performance in the face of regulatory manoeuvring.

But if regulations like MiFiD II and the Basel Accords seem to weigh so heavily on the banks, does the supposed (and still unproven) security of these regulations outweigh the cost increases that may eventually be borne by society?

Let’s look at some aspects of the Basel Accords:

A study by Tilburg University ran cost scenarios for the 2008 Financial Crsis. The QIS reported an average common equity Tier 1 capital ratio (CET1) of 5.7% for Group 1 banks and 7.8% for Group 2 banks. The CET1 ratios of the Group 1 and Group 2 banks compared with a 7% CET1 level, would have resulted in a shortfall of €577 billion for Group 1 banks and €25 billion for Group 2 banks at the end of 2009, suggesting that the increased capital requirements of Basel III would have been effective in cushioning the crisis.

Leverage was a highly statistically significant factor during the crisis. The leverage ratio has both micro and macro-prudential elements, serving to contain excessive risk as a supplement to the capital ratio. In addition, a leverage ratio can operate fully independently of any complex modelling assumptions and calibration procedures, allowing it to complement well with other regulatory parameters.

More indirectly, the Basel Accords push international banking sectors to work towards improved common standards. Financial institutions are likely to invest and conduct transactions where Basel Accords are being implemented since it is assumed that there is additional security in capital circulation. In the long term, this ‘driver’ could help to improve overall consumer expectation and bank performance and hence, greater efficiency in the global economy. This would then contribute to an increase in societal welfare.

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