7 reasons why breaking up the US banks is a bad idea

Christian StrackeBreaking up large US banks to try and prevent another financial crisis may seem like a good idea to politicians, but Christian Stracke (pictured), of Pimco, says it isn’t.

Stracke, the firm’s head of credit research, has published 7 reasons why:

  • Regulations, such as Basel II and the Dodd-Frank Act, are already helping make the banks less risky, as well as their own attempts to shrink balance sheets and complexity.
  • A breakup would be disruptive and could easily spill into reduced lending activity. In other words, a credit crunch, says Stracke.
  • While the new smaller banks might be less exposed to funding shocks, they would still be exposed to all the correlated risks that always plague banking systems, like property bubbles.
  • Many bond-holders realise that the ‘bail-in’ regime – where their bonds may be converted to shares to support a bank – is a reality. Their intolerance of this was an original driver for bank break-ups.
  • Bondholders would be wary of new entities. If the banks were broken up, then which part of the bank would be responsible for the existing debt? Investment banks would require the bulk of bond funding but these could also be “by far” the weakest of the post-breakup new entities.
  • At present, large and systemically important banks are required to run with significantly more capital than smaller one, so a break-up could result in less capital in the system.
  • There could be a potential increase in counterparty risk. Most market participants look for a parent-level guarantee when they trade with the derivatives arm of a large bank. If a subsidiary entity is shorn away from the parent, there would suddenly be significantly more counterparty risk in the system.

Stracke said many politicians and policymakers have grown more aggressively vocal in recent months in their call to break up large and systemically important US banks as a further measure toward preventing another global financial crisis.

“At Pimco, we agree that some of the biggest banks are not at their optimal size. Yet while further measures to encourage simpler and smaller balance sheets and operations may be needed, policymakers need to keep a close eye on their unintended consequences, no matter how politically appealing the measures may seem,” he said.

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