There is a need to have strong regulations in place to restrict the size and interconnectedness of banks, said Joseph Stiglitz, the 2001 Nobel prize winner in economics.
Joseph Stiglitz’s comments assume significance in the wake of Finance Minister P. Chidambaram insisting that India must have at least two-three world-sized banks.
“We must create at least two-three world-size banks, even China has done it,” Chidambaram said at the recent banking conference Bancon in November. He also added that new business models will inevitably lead to some consolidation among banks.
In 1998, Reserve Bank of India-appointed Narasimham Committee on Banking Sector Reforms had recommended restructuring of the banking system to create three-four large banks, which could become international in character, and 8-10 national and local banks. No serious attempt at consolidation in the public sector banking space has happened, though.
It was believed that banks that are too big or too interconnected cannot fail. However, the financial crisis of 2007-08 has taught us different lessons, Stiglitz said while delivering the 15th C.D. Deshmukh Memorial lecture organised by the RBI to honour the memory of the first Indian governor of the central bank.
“Financial institutions which are too big to fail, too interconnected to fail, or too correlated to fail have an incentive to gamble: if they win, they walk off with the profits, if they lose, the public picks up the losses,” the Nobel laureate said.
INCREASE TAXES TO LEVEL THE FIELD
Stiglitz, who is also the professor of economics at the Columbia University in New York, said that taxes on large banks should be levied to “level the playing field."
He said that large banks have an advantage over other institutions because of the implicit guarantee (read: sovereign backing) that is provided to such institutions.
“The private returns to growth in size and to interconnectedness exceed the social returns (which may, in fact, be negative) by a large measure,” he added.
One aspect of “correlated” risk taking is the herding behaviour that marks credit bubbles. Such irrational bubbles are a major source of macro-economic volatility, he said.