Banks are some of the most important institutions in the various economies in the world. Essentially, banks are categorized in terms of big and small banks according to their market share. Commonly, the big and small banks operate in different manners due the operational mandates accorded by their sizes. Understandably, the big banks operate and serve a huge number of customers as well as broad jurisdiction.
On the other hand, the small banks may have fewer customers and cover a smaller jurisdictional area. In most case, however, the small banks are more effective than the big ones because the operational system is easy-to-use. This situation has necessitated the question of whether the big banks should be broken up. This paper will seek to answer this question by supporting and disapprove the idea of breakups.
In essence, economists, managers, and government officials have been trying to help banks whose size it too big to progress. As such, they have determined that the most basic solution is splitting them into small portions. However, it is essentially out of order to embrace this option without conceptualizing the effects that can arise. First, the division of big banks does not essentially decrease the risk exposed to them.
The venture manages to distribute the risk to a number of entities that operate singly without reducing the possible loss. As such, it implies that the breakup does not help the bank to defend itself from a risky situation of financial loss. In perspective, it does not save the customers from the possibilities of insolvency that can arise from the bank’s downfall. In fact, it is noted that the profound and wide-reaching geographical coverage make the banks safe (Acharya 217).
In this regard, the big banks operate internationally in various countries around the world. The globalization implies that the possibility of an unfavorable event to happen varies robustly. As such, the risk is diversified because each country has a varying likelihood of incurring loss-laden events. In fact, the instances of the bedeviled Spanish saving banks indicated that the small institutions lead to huge trouble if they destabilize. In fact, it was established that their risks are intense because each of the banks has a different organizational structure.
Indeed, the idea of discussing big banks does not address and focus the issue of size only. Instead, big banks can be viewed in terms of their scope and investment approaches. In the Spanish cases, most of the big banks were conceived by merging small institutions. These integrations were conducted to integrate both the retail and investment-oriented companies (Bryfonski 167).
The undertaking emerged amidst a crisis that had bedeviled the individual companies. Consequently, many banking rivals merged to form bigger banks that served customers from a big jurisdictional area. This undertaking was aimed to make stable banking institution because the managers understood that such institutions are more solvent than the latter.
Indeed, it is understood that big banks can borrow at a lower cost as compared to the individual ones. It implies that the maintenance of big banks reduced the debts incurred by the banking sector collectively. The main reason as to why the global banks can borrow at a low cost is informed by the principle of cross-subsidy.
Although this aspect is essentially beneficial, it is critical to understand that the cheap borrowing might be facilitated by the wrong factors. For example, the big banks might allow cheap deposits from their retail sections to the investment parts.
In normal circumstances, the bank regulators disregard the pricing process of internal transfers. However, the bank’s cost of borrowing is inherent to the risk incurred when they take loans. If a part of the banking institution gets money at a lower cost than the other one, the overall effect if wrong pricing of the risks taken.
From another perspective, it is evident that the sustenance of big banks is a unique venture as compared to their counterparts. In the modern world, globalization has become a competitive strategy that helps them to flourish. In this regard, the big banks can offer an opportunity that small banks cannot afford. In essence, the big banks that operate globally can help the companies to manage their business worldwide.
On the other hand, the small banks’ operations are limited to small jurisdictions. In addition, the operational approach of the big banks provides customers with more efficient systems. In most cases, customers subscribe to banks where they can access a range of services under one roof.
They do not wish to access one service from a single bank and venture to other institutions later. For example, it is efficient for a customer to make deposits and pay premiums simultaneously. It is not efficient for the customer to access financial services and find an insurance company to get a cover. In this regard, the big banks provide an easy-to-use system for the customers as compared to their counterparts.
Indeed, most of the big banks were made when small companies merged in order to join forces. Understandably, the existence of small banks was a crucial tool of fostering competition among the individual banks. This competition plays a crucial role when it comes to the innovativeness of the banking industry. If the competition is very high, the individual banks struggle to improve the quality of services in order to maintain customers.
On the other hand, low competition index lead to a situation where the banks relax and reduce innovative efforts. As a result, the existence and conception of big banks through merging is dangerous to the economy. Surely, an economy that has deficient innovation tendencies is deemed to fail.
Importantly, if the banks within the economy do not yearn to bring new products to the market, the economy will experience retarded growths. This scenario implies that the breaking of banks can be a tool of increasing competition (Admati 2). Through competition, the banks will discover new products and financial services for the customers. In fact, this strategy can lead to the reduction of the products’ prices for the customers.
The second reason as to why the big banks should be broken up is related to the amount of risks taken by these institutions. The big banks can pool a lot of money and funds in their capital base. As a result, they engage in economically dangerous behavior of risk taking. This condition implies that the banks are pooling and concentrating risks continuously.
The enormous accumulation of the overall risk has become a negative and critical concern. In risk management, institutions should not take amounts of risk that they cannot handle. Otherwise, their system can fail instantly in case an unfavorable event happens. Importantly, big banks, which have a huge capital base and access to funds, have a general tendency to attempt risk taking.
This confidence arises because the owners have the capability to invest. However, the potential and overall risk undertaken by the banks reserve a huge potentiality of loss. If the event of loss occurs, there is a high probability of hurting the investors, shareholders, and the governmental organizations that rely on the mentioned institutions.
Furthermore, the breaking of big banks is advantageous when it comes to the regulatory capability of the relevant overseers. In this case, it is established that the financial overseers can make regulations that are inherent to the mix of activities when working with small banks.
For instance, the big banks should be orders to have specified capital requirements. This requirement emerges because the challenges incurred due to cross-border processes make the difficulties complicated. The banks that handle derivatives when managing risks can be subjected to different rules from the ones that offer loans. This condition implies that the smaller banks have specified investments’ approaches that inform the manner of regulations.
It is evident that the issue of breaking up the big banks has evoked controversial debates worldwide. However, this paper has indicated that the breaking has more disadvantages than benefits. It indicated that the big banks have the capability to borrow funds at low costs and manage huge risks. In addition, the banks can manage global companies and help them to sustain their businesses worldwide. On the other hand, the splitting is supported on the basis that big banks take huge risks that are dangerous to the economy.
Acharya, Viral. The Social Value of the Financial Sector Too Big to Fail or Just Too Big? Singapore: World Scientific Pub., 2014. Print.
Admati, Anat. “Should Big Banks Be Broken Up?” The Economist Debate 5.4 (2013): 1-3. Print.
Bryfonski, Dedria. The Banking Crisis. Detroit: Greenhaven, 2010. Print.