March 19, 2019 / 3:43 PM / a month ago

U.S. big banks remain complex despite post-crisis simplification goals, Fed paper finds

NEW YORK(Thomson Reuters Regulatory Intelligence) - Despite apparently reduced number of legal entities, the level of complexity remains high for large U.S. banks 10 years after the financial crisis, according to a Federal Reserve staff paper.

An employee of puzzle maker Beverly holds a piece of the company's white micro 1000 piece jigsaw puzzle at the International Toy Show in Tokyo June 14, 2012.

Drawing on the annual reports of bank holding companies, or BHCs, and reports of changes in their organizational structures, the study analyzed bank complexity based on the firms’ geographic footprint, organizational structure, and the extent of their business operations.

The paper{here} was written by Linda Goldberg of the New York Fed and April Meehl of the University of Wisconsin-Madison. It builds on previous research findings that big banks have not shrunk in size since the financial crisis of 2008, and shows that the banks have also remained complex, despite a drive to reduce instability risks by simplifying the financial system.

“Simplification of bank complexity was one of the policy priorities of the post-crisis period,” the paper said. “Regulatory frameworks continue to focus on limiting the risk of failure by improving risk absorption capabilities and on improving resolution mechanisms for dealing with these BHCs in the event of failure. Some forms of BHC complexity significantly declined, even while the largest of the large remain highly complex on organizational, business, and geographic dimensions,” it said.

NOT SO COMPLEX AT THE TOP

On the face of it, the top 50 largest bank holding companies, representing 85 percent of the bank holding company assets in 2017, have become leaner from a regulatory perspective. The average number of their legal entities declined from 232 to 189. The share of large and complex BHCs with any foreign affiliates also declined slightly from 58 to 54 percent, although some of this decline is attenuated by a larger reduction in domestic entities.

This apparent decline in organizational, business, and geographical complexity, however, fails to capture the full picture, the study found.

SHIFT FROM TRADITIONAL FINANCIAL ACTIVITIES

Big banks have shifted the composition of their financial subsidiaries away from traditional bank and nonbank activities such as commercial banking or insurance, into areas such as portfolio management, and “other securities activities.”

The total share of subsidiaries related to housing, real estate and management companies within nonfinancial entities have also risen significantly within from 2007 to 2017. “Management companies are the most popular nonfinancial affiliate, with the five largest BHCs holding an average share of around 30 percent of all nonfinancial entities,” finds the paper. The research also reveals that the share of housing subsidiaries for the five largest BHCs rose from 10 percent in 2007 to 25 percent in 2017.

MORE RESEARCH REQUIRED

Regulators have, on numerous occasions, sought to reduce complexity in bank organizations{here}, through various measures such as extra cushions of loss-absorbing capacity, changes in banks' organizational structures, and periodic reviews of resolution capacity.

As the paper observes, “greater complexity can contribute to agency problems and make a failing bank harder to resolve, adding to systemic risk and the “too complex to fail” problem.

Given that “some forms of BHC complexity significantly declined, even while the largest of the large remain highly complex on organizational, business, and geographic dimensions,” the paper called for more research into what would be considered an optimal level of complexity in U.S. bank holding companies.

*To read more by the Thomson Reuters Regulatory Intelligence team click here: bit.ly/TR-RegIntel

(Bora Yagiz, FRM is a New York-based Regulatory Intelligence Expert for Thomson Reuters Regulatory Intelligence, specializing in risk. )

This article was produced by Thomson Reuters Regulatory Intelligence - bit.ly/TR-RegIntel - and initially posted on Mar. 12. Regulatory Intelligence provides a single source for regulatory news, analysis, rules and developments, with global coverage of more than 400 regulators and exchanges. Follow Regulatory Intelligence compliance news on Twitter: @thomsonreuters

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