Big Banks, That Should be Small Banks, Hog Tie Themselves with Compliance

Q: What is the major reason for the litany of regulatory and legal breaches committed by just about every major banking institution over the last decade?

A: The banks have gotten too big.

It is well known that as an enterprise grows, it becomes more difficult to monitor and control its operations. While a two-man partnership operates very effectively with each partner monitoring t actions of the other, it is inconceivable how the CEO of May 250,000 employee bank can know 99.9% of what is taking place in his institution. Needless to say, compliance breaches follow.

The London whale at JP Morgan is an example of the loss of control that comes from being too big. The bank needed to invest significant deposits taken as part of their day-to-day business, but in so doing the bank’s positions in the credit markets were too large.

So if the banks are too big, so that they are prone to infringement’s which may lead to their own failure and in a wider sense systemic problems, then the logical conclusion is to get small. Returning to a smaller, employee owned business model would help rectify the control lapses that we have observed. The big banks should breakup, right?

Breakup? Not so the big banks. At the behest of regulators, they have resorted to hiring thousands of additional compliance and legal employees, who are neither financial experts nor correctly incentivised to be able to operate a profitable business. The new compliance culture that is supposed to save the big banks very existence is effectively hog tieing their operations. Clients are refused transactions, bankers and market professionals are restricted from making entreaties, and in the end revenues suffer and people leave to start boutiques.

From a regulator’s standpoint, it is much easier to supervise a small number of big banks than a large number of new boutique operations that service a broad range of client objectives. The next decade will see an explosion in small boutique financial companies. Regulators who thought that encouraging the big banks to hire compliance resources are about to have their work cut out for them.