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German López Espinosa, Professor at School of Economics and director of Master's Degree in Banking and Financial Regulation at the University of Navarra.
Antonio Rubia Serrano, Professor at the University of Alicante
The effects of concentration on the stability of the banking system
The recent lowering of interest rates to 0% by the ECB has exacerbated the complicated economic situation facing the banking system. On the one hand, the low interest rates of reference letter for loan operations - at all-time lows - have considerably reduced the profitability of the sector's lending activity. It should come as no surprise, therefore, that Spanish banks have resorted in recent years to alternative sources of income, such as, among others, income from commissions. At the same time, the increased regulatory and supervisory requirements imposed on the sector after the financial crisis have meant new costs for banks, resulting from the need to allocate greater human and technical resources to comply with these obligations, to invest in information systems, and to rely on specialized external advice.
As result, the banking sector is facing increasing difficulties in making its traditional model business profitable. Unless the low interest rate status reverses in the medium term deadline -a scenario that, as of today, seems increasingly distant- it is very likely that banks in Spain and in other developed countries will embark on sector concentration processes through mergers and acquisitions. The convenience of this strategy obeys an unappealable economic logic: sector concentration would allow banks to generate higher revenues in a context of lower skill and, at the same time, reduce their operating costs through synergies and economies of scale. The problem of leave profitability raises the minimum size necessary for a bank to survive. The lack of flexibility of the labor market in our country, in terms of cost and time needed to implement the adjustment, means that this minimum size must be even greater, which is not the case in more flexible labor markets, such as the United States.
On the other hand, from the point of view of system stability, the concentration strategy could have certain apparent benefits in the short term deadline, given that, in principle, it would offer greater guarantees of subsistence to the entities that emerge from the concentration process. However, in the long term deadline, concentration also implies great risks for the stability of the banking system. In Spain, where after the crisis there is already a strong Degree of bank concentration, this process could lead to a scenario characterized by a reduced issue of financial institutions, with a massive size, highly interconnected and operating under virtual oligopoly conditions. Is this scenario desirable?
The enormous costs of the bailout of large savings banks are a painful reminder of the risk that oversized institutions can pose for taxpayers and investors. In a recent work of research that we have elaborated together with professors Marina Balboa (University of Alicante) and Antonio Moreno (University of Navarra), we have tried to determine the size threshold that empirically defines systemic importance. To do so, we analyzed the financial sector in the United States in the period 1990-2014, observing that in banks with assets above $250 billion any negative shock is transmitted to the financial system, which justifies the regulatory requirements in force for this class of banks. On the other hand, in banks with total assets below 100 billion assets, we find that only shocks of high magnitude have the capacity to transmit to the financial system and pose a real threat to the system.
This evidence, based on the systemic episodes experienced in recent decades, is a warning of the risks inherent in oversized banks. Moreover, from a historical perspective, it is extremely worrying to note that the severity of systemic contagion occurred in an environment of less concentration than the current one. In the United States, with a population of 318 million inhabitants, after the financial crisis there are 6,402 cooperatives at credit , known as "Credit Unions", 4,660 banking groups classified as "Bank Holding Companies" and 1,905 banking groups classified as "Commercial Banks", which means a greater sectorial dispersion in relative terms than that existing in Spain. The direction in which everything seems to indicate that the Spanish banking industry will move in the coming years is terra incognita and raises questions that should not be underestimated. In a context of excessive banking concentration, the effect that a new banking crisis would have on the stability of the system and the effectiveness of the tools available to tackle it (recovery plans, resolution plans, bank resolution fund, outline deposit guarantee fund, etc.) are uncertain, as historical precedents may be a basis for estimating the magnitude of the problem.
Neel Kashkari, President of the Federal Reserve Bank of Minneapolis, is stimulating discussion in the United States on the excessive size of banks. To this end, he proposes to evaluate the convenience of three alternative measures as a possible solution: promote spin-offs in the banking sector to reduce the size of banks, increase the level of regulatory capital, or provide fiscal disincentives for indebtedness. Unfortunately, none of these alternatives seems plausible in Spain given the current economic circumstances and the particularities of the market. Therefore, and in view of the probable strategy that banks will undertake in the coming years, it is necessary to analyze measures focused on limiting an excessive level of concentration given the potential financial costs derived from a status of banking instability. In this sense, banks would have to bear in mind that a feasible future solution if the Degree of concentration proves to be excessive would be to grant banking licenses to foreign groups interested in our market, at the moment that interest rate hikes are expected, given the importance that this could have in ensuring the stability of the system.
At final, it seems appropriate to reflect on and debate the negative consequences that a process of excessive concentration in the sector could have on the stability of the Spanish banking system, being aware that this strategy is currently possibly the only lever for profitability in this industry.