Scale vs. Concentration Risk in US Commercial Banking

Have we unwittingly invited looming disaster in our commercial banking sector?


Declining prices and margins for banking services have driven consolidation for several decades.


The share of deposits among the top 5-6 banks is much greater now than a decade ago, and certainly much more than two decades ago. BofA is at the point of being prohibited from further acquisitions, without some careful accommodations, due to its deposit share bumping up against single-bank limits.

Surely a great benefit of this consolidation has been the expansion of consumer and housing credit, as well as more competitive and competitively priced asset management services.


But the flip side of these low cost, ubiquitous products and services is concentration of banking risk in only 5-6 firms.

Now, one large mistake has a much greater impact on US deposits, loans, money trading, etc.


Have we unwittingly gone to far in fostering consolidation, while also removing Glass-Steagall?


Wouldn't it be ironic if Sandy Weill, a non-banker, and not even an investment banker, at that, but merely a low-end retail brokerage 'consolidator,' was the ultimate cause of severe risk in the US commercial banking system?


By forcing the repeal of Glass-Steagall with his merger of Travelers and Citibank in the 1990s, Weill removed a major barrier to risk concentration in the US banking sector.


Was that really wise?


Would the current credit crisis have become so serious if the commercial banks, notably Citi and BofA, were not allowed to engage in securitization of their loans to customers, but, per Glass-Steagall, were prohibited from engaging in anything resembling investment banking and the issuance of such securities?


If those two banks had been forced to either be portfolio mortgage lenders, or package their loans through Fannie or Freddie, would the SIV debacle have occurred? Would they have engaged in subprime lending or issuing or holding suspect CDOs?

My long-ago mentor at Chase Manhattan Bank, then-SVP of Corporate Planning & Development, Gerry Weiss, was fond of saying, when asked about working to remove Glass-Steagall, something like,

'Are you kidding? We'll just find some new ways to lose a lot of money on badly risk-managed positions. Not to mention that, being commercial bankers, once we get into these businesses- M&A, underwriting, equity trading- we'll cut prices to gain share and ruin the business' profitability for all concerned.'

Judging by the behavior of Citigroup and BofA in last summer's CDO, SIV and other fixed income messes, I'd say he was right on the money, as it were, as usual.

Commercial banks appear to be no better off in terms of profitability, risk management or total return after the repeal of Glass-Steagall.

I'll go so far as to say that, for the safety of our banking system, we probably should reinstate the law. Because, at the rate the large commercial banks are making risk-management mistakes, it's only a matter of a few years before one of the big five - Citi, Chase, BofA, Wachovia, Wells Fargo- commercial banks blows a hole in its balance sheet to large to self-repair, and will require Federal intervention to stabilize it and sell the remnants.