macroresilience

resilience, not stability

Diversity and the Political Economy of Banking

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From a system resilience viewpoint, there are many reasons why a reduction in diversity is harmful. But one of the lesser appreciated benefits of a diverse pool of firms in an industry is the impact it has in reducing the political clout that the industry wields. Diversity is one of the best defences against crony capitalism. As Luigi Zingales explains, commenting here on the political impact of Gramm-Leach-Bliley: “The real effect of Gramm-Leach-Bliley was political, not directly economic. Under the old regime, commercial banks, investment banks, and insurance companies had different agendas, and so their lobbying efforts tended to offset one another. But after the restrictions were lifted, the interests of all the major players in the financial industry became aligned, giving the industry disproportionate power in shaping the political agenda. The concentration of the banking industry only added to this power.”

There’s been a lot of discussion recently on the merits of breaking up the big banks and one of the arguments in favour of this policy is the perceived reduction in the political clout that the banks would possess. Arnold Kling, for example, lays out the thesis in this recent article. Breaking up the banks may help but I would argue that the impact of such a move on the political economy of banking will be limited unless the industry becomes less homogenous.

The prime driver of this homogeneity is the combination of the moral hazard subsidy and regulatory capital guidelines which ensures that there is one optimal strategy that maximises this subsidy and outcompetes all other strategies. This strategy is of course to maintain a highly levered balance sheet invested in low capital-intensity, highly-rated assets.

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Written by Ashwin Parameswaran

April 6th, 2010 at 4:21 pm

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