Too Big to Fail: Markets Abhor a Vacuum

Some characteristics of the TBTF challenge are specific to Asia, but these may be intractable from ‘winner-takes-all’ capitalism and national interests, writes industry veteran Jamie Lloyd Evans.

The film adaptation of Jessica Bruder’s “Nomadland”, which recently won the top prize at the Venice Film Festival, is a poignant reminder of the human cost of the last financial crisis for a generation of older and impoverished Americans.

More than a decade has passed since the 2008 crisis and it is fitting that the FSB (Financial Stability Board) is currently evaluating its policy response to one of the most egregious aspects of that crisis, namely the ‘Too Big To Fail’ problem, or TBTF.

In 1999, the BCBS (Basel Committee on Banking Supervision), on the tenth anniversary of the Basel I framework attempted a similar evaluation and drew the only possible conclusion – that it was difficult to say that the policy had achieved its purpose with any high degree of confidence.

There are elements of the same cautious humility in the FSB’s 133-page Consultation Report (notwithstanding slightly facile statements on the “net benefits to society”) and I believe that it is a genuine attempt to tackle an almost impossible task.

Personally, I would have liked the Report to have taken a deeper look at some of the second- or even third-order effects, but I have no desire to critique the FSB’s efforts here. Instead, I would like to offer a few comments arising from the Report that relate to Asia specifically.

Rise of the D-SIB

Firstly, the Report seems to substantiate a position that I have advocated for some time: namely, that regulatory reforms have contributed to the rise of the D-SIB in Asia at the expense of the diminished – mainly European and US – G-SIBs operating in the region.

“As for D-SIBs, in the Asia-Pacific region they have increased their market share.” 

Granular data in support of this claim are not presented in the Report itself, but I believe that this could be an accurate generalisation for a vast region of the world.  It also suggests that TBTF risk has been re-situated away from foreign G-SIBs to domestic banks that have grown their market share in the post-crisis period. Arguably this has contributed to emerging excesses that have drawn the attention of commentators and regulators alike.

Other factors have also led to this outcome, and I would argue that the introduction of the LCR (liquidity coverage ratio) within the Basel III framework has intensified the local currency pricing advantage of the D-SIBs, due to their (sometimes highly protected) home deposits base.

Asia goes its own way

Secondly, the Report acknowledges what CRAs (credit rating agencies) have been telling us for the last three or four years, namely that the TBTF reforms have not been fully effective in Asia, where bank bail-outs are still far more likely than bail-ins:

“…in some jurisdictions such as Japan, Singapore and Australia, CRAs do not judge the framework to be fully effective, because of the state’s propensity to support… In other jurisdictions, notably in much of Asia and in the Middle East, the frameworks are not judged to be effective, because implementation of reforms is incomplete.” 

Strangely, the Report doesn’t connect the two points, i.e. that D-SIB risk in Asia has increased at the same time that Asia has largely remained sceptical about the FSB’s prescribed resolution toolkit.

The reasons for this scepticism are complex but ultimately reduce to questions of culture and polity and the relationship between bank and state. Implicit in this point may also lie the charge of underlying Western bias within the reform agenda, which is arguably not confined to the TBTF issue alone.

Filling the void

Thirdly, the Report notes the possibility that the non-bank or shadow banking sector may have taken up the slack where G-SIBs have withdrawn or reduced their activities.

In Asia, the rise of digital wallets and payments providers together with a new breed of licensed digital/virtual banks could be construed as a counterweight both to the increased dominance of D-SIBs in local economies, as well as the diminution of foreign G-SIBs.

It is important to note that the foreign G-SIBs in many Asian countries were often responsible for the introduction of new technologies and would act as funnels of talent and know-how into domestic markets. This is no longer the case, as Asian Bigtech is already poised to fill that void.

Moving on

I wish the FSB well as it seeks to improve and mold the policy response on TBTF, but feel that it has its work cut out on two fronts.

On the one hand, the TBTF challenge is woven into the fabric of the increasingly dominant type of ‘winner-takes-all’ capitalism that is prevalent in many markets.  TBTF is a subtext that is both a consequence and intended outcome of business models that are unchecked by politics, regulation or social conscience to a large extent. This overriding focus on market dominance was epitomised in the words of the early Facebook investor, Peter Thiel, who famously said: “competition is for losers”.

Market sentiment and valuations already reflect this mindset across a range of industries, and banks are not immune to its effects given their reliance on markets to raise capital, while the threat from Bigtech/fintech has emerged from the very same school of thought.

On the other hand, the FSB has to contend with the fact that many banks enjoy protected and monopolistic positions in their home markets that are justified on the grounds of national interest, or more specifically, financial stability.  This apparent contradiction or tension in relation to the TBTF challenge draws our attention to the essentially political nature of the FSB’s task of coordination at the global level.

Nevertheless, it seems to confirm the direction of travel towards a world in which banking markets are increasingly closed systems drawn along national boundaries, in which cross-border systemic risk is constrained but the build up of domestic systemic risk may be an inescapable necessity.

I am not sure that this is where we want to end up, but what is clear to me is that we are all nomads: the ultimate destination of our journey will never really be known, but we live for and by its milestones.

Jamie Lloyd Evans is a seasoned financial services practitioner who has experience as a banker, regulator, and advisor in the fintech space. Most recently, he led the Financial Institutions Group at Citigroup in Singapore and Hong Kong, straddling both the investment banking and corporate banking businesses. Prior to this, Jamie held policy roles at both the MAS (Monetary Authority of Singapore) and the UK’s FSA (Financial Services Authority), where he advised on all aspects of prudential regulation for banks and insurers, particularly in the areas of capital adequacy and corporate treasury.

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