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Banks May Be Too Big, Bank Of England Warns

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Banks may be too big, Bank of England warns

LONDON (MarketWatch) -- The world's biggest banks may simply be too big, making them incompatible with efforts to maintain financial stability, the Bank of England said Friday in its semi-annual financial stability review.

"Financial systems have grown rapidly in recent years and have become more complex, more interconnected and more global in their activities," the report said. "The U.K. financial system is no exception, with a relatively concentrated banking system whose assets are equivalent to more than four times annual GDP."

The language echoes recent remarks by Bank of England Gov. Mervyn King and underlines differences with the U.K. Treasury and the Financial Services Authority. The Treasury and FSA have argued that identifying and controlling risk are crucial to maintaining stability, regardless of an institution's size.

Analysts at Nomura said the report was negative for banks overall and for big U.K. banks such as Lloyds Banking Group /quotes/comstock/23s!a:lloy (UK:LLOY 66.49, -0.01, -0.02%) , Barclays /quotes/comstock/23s!a:barc (UK:BARC 268.10, -1.65, -0.61%) and Royal Bank of Scotland Group /quotes/comstock/23s!a:rbs (UK:RBS 38.13, +1.38, +3.74%) , in particular.

"Lloyds appears negatively affected by the issues of scale and domestic margin/funding, while Barclays and RBS would also be affected by these issues and measures to limit complexity," the analysts said, in a research note.

The Bank of England urged British and international authorities to consider limiting the size and structure of the financial system.

Possible measures include limiting the scope of banks' businesses to a narrower range of low-risk activities. Another possibility would be to force banks to meet higher capital and liquidity requirements in line with each institution's risk profile.

"Such measures ought to go hand in hand with improved resolution powers to wind down large and complex financial institutions in an orderly manner," the bank said.

Any changes should be aimed at improving the resilience of the overall financial system, the report said, noting that a "systemic perspective has perhaps not always shaped policy around the world sufficiently in the past."

Meanwhile, Chancellor of the Exchequer Alistair Darling plans to introduce a new banking law this year that would boost the FSA's role, the Financial Times reported Friday.

The move would give the agency new responsibility for maintaining financial stability, a function that is currently the responsibility of the Bank of England, the newspaper said.

Darling is expected to outline the proposal in a Treasury white paper next week. King, testifying in a parliamentary hearing on Wednesday, complained that he had not been consulted about the upcoming paper.

The BOE report said the nation's banks are more stable than they were six months ago, but warned that shocks could still destabilize the financial system. In a potential vicious circle, a stall in the economic recovery due to weak bank lending could cause losses on assets to rise, further undermining confidence in the banking sector, the bank said.

The report noted worries about the exposure of western banks to countries with large current account deficits. Further falls in cross-border lending and a rise in sovereign risk could prompt banks to tighten credit conditions, which could then pose a new threat to stability.

Governments could extend bank bailouts and other measures announced earlier this year, the report said. But in countries with high public debt levels and large banking systems relative to the overall economy, markets could begin to question the scale of further government support.

"At some point there would be a risk of fiscal injections raising sovereign risk and ... amplifying, rather than dampening, pressures on the banking sector, for example in funding markets," the report said. "While most countries are not yet at this point, it is a factor to weigh when assessing options."

Possible alternatives would include programs that attempt to split costs between the public and private sectors, such as the Public-Private Investment Program introduced in the United States. Or banks could be allowed to restructure their liabilities, such as through the conversion of subordinated debt to equity, or to split their balance sheets into a "good bank" and a "bad bank."

Well, the banks are indeed more stable with a 100% guarantee of instant re-liquidity via the taxpayer, thanks to government.

What worries me is that this statement was made for the wrong reasons. Yes, it is a moral hazard to have these big super banks, as they monopolize the market and have the ability to cease all transactions should they be pressed too hard or rubbed the wrong. My feeling is that government and the BOE fear the super bank for the other reason; their ability to usurp the state.

Let's wait and see how this develops, as that's all we are allowed to do in Britain anyway.

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