Competition vs safety

Alistair Darling says he wants a “safer, more competitive banking system.” But isn’t there a trade-off between these two goals?
I mean, competition generates instability, because firms that lose crash out of business. Schumpeter’s “perennial gale of creative destruction” will blow some companies away.
We saw this in the UK mortgage market in the earlier 00s. This was competitive; margins were bid down as some incumbents, notably Northern Rock, expanded and alternative lenders entered the market. But - we now know - it was also unstable. Not only did Northern Rock collapse but non-bank lenders have now all but disappeared.
In this context, we should ask whether Darling’s proposals to split up the banks really will increase competition.
The reason for doubt is simple. Competition requires not just there be many sellers, but that the sellers want to expand; it’s companies’ desire to sell more that bids prices down. However, if banks are required to have high capital-asset ratios, or large liquidity buffers, then their ability to expand will be limited. And this limits competition.
It might be this that explains a curious finding by the World Bank - that, across countries, there’s no significant link between concentration in the banking sector and net interest margins. Numbers alone aren’t always sufficient to produce real competition.
I say all this not to dismiss Darling’s proposals, but rather to raise a more fundamental question about our attitudes to economic systems. Fierce competition gives us innovation and lower prices, but also instability and uncertainty. Is the gain worth the pain?
It’s easy today to believe that the costs of instability are prohibitive. But is the availability heuristic biasing us towards this? Or is it instead the case that, as James Tobin said, it takes a lot of Harberger triangles to fill an Okun gap?

Comments

[Adam]

Firms that lose tend to get taken over by the winners rather than crashing out of business.

And the instability was systemic, not a result of too much competition.

[chrisg]

I think you might get different answers to your question depending on whether you're considering systemically important financial institutions whose creditors are underwritten by the taxpayer competing in an inadequately regulated market, and other kinds of firm.

For the former, I doubt it matters how many such institutions are competing - you will get instability and the associated costs. (Weren't Fannie Mae and Freddie Mac essentially monopoly providers?) But for most other markets it's hard to see how reducing competition could make sense, because the costs of instability aren't that great - in most cases, as Adam suggests, the winning firms just take on the employees in the losing firms as they grow.

Then there are major shifts in the economy as a result of technological change e.g. the death of the physical letter. But without becoming another North Korea it's hard to see how you stop that from happening.

[Diversity]

Tesco Bank? Might compete by making household banking more convenient - and floating some loss leaders?

Virgin Bank? Mr Branson has a record (with mixed success) of trying to compete differntly.

Williams and Glyn? How will they enrich competition?

Surely it is different ownership/management structures which we (and the European Commission) should look to to improve competition, not just reduced concentration in a highly regulated field?

And the missing player in the restructuring talk is a new type of mutual to add to the Co-op Bank, Nationwide, etc. It is perfectly possible. All the Treasury needs to do is label some of the new money they are advancing as participations in the new mutual, which the mutual will in due course buy in out of profits.

[Luis Enrique]

Does anybody know why the likes of the Co-op and Nationwide are unable to offer more favorable rates than their rivals?

Other banks have to pay out all those disgusting bonuses and shareholder dividends - with the ability to direct that money toward their customer-members, why don't the mutuals kick ass, competitively?

Is it because the other banks engage in all this shady wheeling and dealing, with collateralized whatnots, making pots of money therein, and allowing them to offer comparable rates to the mutuals?

Are, the the incentives with mutuals such they they are simply less efficient in a straightforward kind of way?

[Mark]

Banking is inherantly different from other industries because banks don't know whether they are making a profit on their current business until a few years later. Unprofitable banks (in hindsight)had been taking share from the profitable banks for years. The fact that the government then saves the least profitable banks compounds the problem.

[Glenn]

The official statisticians of the nation can't even work out the value added (GDP) of the financial services industry... tells you how murky it really is...

[reason]

Mark
has it. But it is not just banks. Insurance is the same.