JPMorgan Chase has had a bad year. Not only has the bank just reported its first quarterly loss in more than a decade; it has also agreed to a tentative deal to pay US$4 billion to settle claims that it misled the US government-sponsored mortgage agencies Fannie Mae and Freddie Mac about the quality of billions of dollars of low-grade mortgages that it sold to them. Other big legal and regulatory costs loom. JPMorgan will bounce back, of course, but its travails have reopened the debate about what to do with banks that are “too big to fail.”
In the US, policymakers chose to include the Volcker rule (named after former US Federal Reserve chairman Paul Volcker) in the Dodd-Frank Act, thereby restricting proprietary trading by commercial banks rather than reviving some form of the Glass-Steagall Act’s division of investment and retail banks. However, US senators Elizabeth Warren and John McCain, a powerful duo, have returned to the fight. They argue that recent events have shown that JPMorgan is too big to be managed well, even by cheif executive Jamie Dimon, whose fiercest critics do not accuse him of incompetence.
Nonetheless, the Warren-McCain bill is unlikely to be enacted soon, if only because US President Barack Obama’s administration is preoccupied with keeping the government open and paying its bills, while bipartisan agreement on what day of the week it is, let alone on further financial reform, cannot be guaranteed. However, the question of what to do about huge, complex, and seemingly hard-to-control universal banks that benefit from implicit state support remains unresolved.
The “school solution,” agreed at the Financial Stability Board in Basel, Switzerland, is that global regulators should clearly identify systemically significant banks and impose tougher regulations on them, with more intensive supervision and higher capital ratios. That has been done.
Initially, 29 such banks were designated, together with a few insurers — none of which like the company that they are obliged to keep. There is a procedure for promotion and relegation, like in national football leagues, so the number fluctuates periodically. Banks on the list must keep higher reserves, and maintain more liquidity, reflecting their status as systemically important institutions. They must also prepare what are colloquially known as “living wills,” which explain how they would be wound down in a crisis — ideally without taxpayer support.
While all major countries are signed up to this approach, many of them think that more is needed. The US now has its Volcker rule (though disputes between banks and regulators about just how to define it continue). Elsewhere, more intrusive rules are being implemented, or are under consideration.
In the UK, the government created the Vickers Commission, named after its chair economist John Vickers, to recommend a solution. Its members proposed that universal banks be obliged to set up ring-fenced retail-banking subsidiaries with a much higher share of equity capital. Only the retail subsidiaries would be permitted to rely on the central bank for lender-of-last-resort support.
A version of the Vickers Commission’s recommendations, which is somewhat more flexible than its members proposed, is in a banking bill currently before parliament. A number of MPs want to impose tighter restrictions, and it is difficult to find anyone who will speak up for the banks, so some form of the bill is likely to pass, and big British banks will have to divide their operations and their capital.