We tend to associate size with security, particularly when it involves our funds. The towering skyscrapers and recognizable logos of large banks convey an air of solidity and safety. But is this illusion correct? Might the enormity and regulatory monitoring of these banking behemoths actually serve to conceal hidden vulnerabilities? This page contends that the security we accredit to large banks is most times illusory, a skillfully crafted facade that can collapse in the face of systemic risk and unintended crises.
Historical Context
The financial crisis of 2008 is a dismal reminder of how even the biggest financial institutions can be so frail. Many of the largest U.S. banks that were ‘too big to fail’ seemed on the verge of collapse during the crisis, with the federal government stepping in to prevent their total failure and apparent disaster for the world economy. This rescue operation was no doubt successful, in that it prevented immediate catastrophe and saved many millions of people from even worse outcomes. But these actions may also have had some very unintended effects.
Current Landscape
The trend of consolidation in banks persists, resulting in increasingly larger and more interlinked financial institutions. Although economies of scale and greater efficiency are commonly advanced as advantages, this concentration of power also increases systemic risk. Failure of a single mega-bank can create a domino effect on the overall financial system, overshadowing even that of smaller banks’ failures. The very phrase “too big to fail” generates a moral hazard, risking inducing riskier action with knowledge of a safety net being available.
Key Factors that Create Illusion of Safety
There are a number of factors involved in creating this illusion of safety. Regulatory structures, as well as being aimed at protecting the financial system, frequently find themselves unable to match the pace of rapid innovation and rising complexity in financial products. Loopholes and unforeseen effects can continue to permit great risks to accrue undetected.
Also, the sophisticated nature of today’s financial products can conceal the actual extent of risk, even for sophisticated participants. Public confidence, built up over decades of advertising and reinforced by media stories, also contributes to the perpetuation of the myth of big bank invincibility. Yet history has demonstrated that even the most respected institutions can fail.
Conclusion
The seeming safety of big banks is a reassuring idea, but one that needs to be critically examined. The past record and inherent danger of giant, interlocked financial institutions imply that this security is by no means assured. Placing sole reliance on a bank’s size and perceived strength can breed overconfidence.
Consumers and investors need to see behind the veneer, recognize the underlying dangers, and weigh the possible advantages of diversifying their financial assets across various kinds of institutions. True financial security rests in well-informed choices, rather than in the illusory protection of bulk.