The Reform of ‘Too-Big-To-Fail’ Bank: A New Regulatory Model for the Institutional Separation of ‘Casino’ from ‘Utility’ Banking

Abstract

President Obama’s proposed legislation for the separation of ‘casino’ from ‘utility’ banking has re-ignited the relevant debate. Behind the Obama proposals is the belief that the ‘too-big-to-fail’ banks were among the principal causes of the global financial catastrophe. Although most of Europe did not have any restrictions regarding the kind of business that deposit-taking banks could undertake, the mega-bank business model is mostly a creature of the 1990s. It emerged as a result of a merger wave between investment firms and banks, which became possible because of the deregulation of the western financial services industry. Those mergers were the answer of the financial services industry to the challenges posed by globalisation and financial innovation. Today, the emergence of mega-banks is a development that is much lamented. ‘Too-big-to-fail’ banks fostered excessive risk-taking, as they enjoyed an implicit government guarantee for their aggressive speculation in global capital markets. Yet during the 2007-2009 crisis ‘too-big-to-fail’ banks just became considerably bigger. This has created the ‘biggest moral hazard of our times’. Moreover, the fiscal burden of bank rescues and the fact that ‘too big to fail’ adulterates free market principles and Schumpeterian capitalism make the search for a solution ever more pressing. This paper argues that, if the correct typology is given to various banking activities, separation is possible and may not be more expensive than suggestions for multiple layers of capital regulations. As such the paper presents for discussion a model that provides for three types of banking institutions. The successful implementation of this or of any other similar model requires strong international consensus. The lack of such consensus is the biggest shortcoming of the Obama plan.

Keywords: 'Too-big-to-fail' banks, 'casino' banking, 'utility' banking, global financial crisis, global regulatory reform, Glass-Steagall Act, global banking

JEL Classification: F30, G15, G21, G38