I had the opportunity to attend a Banking Conference in Mumbai organised by IBA & FICCI. The Theme was “Navigating succesfully in an uncertain world”. Speakers discussed about the current financial crisis and what needs to be done. Some of the points that regularly featured in most speaker’s action plan or suggestions where:
Increase Capital in Banks;
Better Risk Management;
Better Regulation (not increased Regulation); among others.
What caught my interest was “Consolidation“. Every other speaker was taking about the need for BIGGER banks to ride through the crisis. Size will help banks whether the storm.
I think the BIG size was the major reason for the Crisis we are currently facing.
Let’s have a look at the some of the institutions that were affected by the crisis – Bear Stearns, Lehman Brothers, AIG, Freddie Mac, Fannie Mae, Washington Mutual, Fortis to name a few were all BIG.
All had substantial exposure to either mortgages or CDOs with Very High Leverage Ratios.
Now, how these institutions were allowed to build such big exposures – they were BIG enough to know what risk they were taking and to take care of themselves.
Since they were BIG – people believed in them, people traded with them, other banks & FIs from across the world bought their securities/CDOs, rating agencies assigned high ratings, regulators & policy makers did not look deeply into there actions. All because they where TOO BIG and common misconception that since they were BIG what they did was RIGHT.
But the World has been proved WRONG. These BIG institutions have created a mess has a far more devastating global impact than what anybody would have imagined.
When you are big, people tend to follow you blindly. Reputation preceeds logic. Companies need to be extra careful in what they are doing, to avoid setting a blind precedent for doom for the entire economy. In the current scenario where there was no Self-regulation and insufficient regulation, Big Institutions actually begin to be a risk to the system.
Now, policy makers are rescuing these BIG Institutions since they are TOO BIG to be allowed to fail. Their failure will have ripple effect on the financial industry & the economy on the whole. Policy makers are throwing comman man’s Tax money to these institutions and trying to rescue them.
Ultimately, the common man is affected more when Tax money is spent on rescuing companies and not on building vital infrastructure or support services.
Is Consolidation really a solution to the current crisis or just a way to another crisis in the future?
Consolidation helps in building economies of scale and lower cost of delivery of services. But with no or loose regulation/supervision they are a greater risk to the economy at large as we are currently experiencing.
Consolidation is useful but only under stringent regulations and ethical practices. But is the Capitalist Corporate World ready for this?