Like the impact of an elephant herd grazing on grassland, multinational banks shape the financial environment to an extent that far outweighs their small number. And like a contagious person on a transnational flight, when these giant, interconnected banks succumb to financial ills, they are uniquely positioned to infect wide swaths of the financial system.
Researchers from Princeton University, the Bank of England and the University of Oxford applied methods inspired by ecosystem stability and contagion models to banking meltdowns and found that large national and international banks wield an influence and potentially destructive power that far exceeds their actual size.
When a large bank -- defined as having various holdings and extensive connections -- falters widespread financial loss and a virulent drop in confidence can quickly consume a financial system, the researchers report in the journal the Proceedings of the National Academy of Sciences (PNAS). Systems like those in the United States in which a few banks hold most of the assets amplify these effects.
As a result, the capital that current regulations require large banks to maintain should not be based solely on its own risk, but also on the institution's systemic importance, the researchers suggest. This would mean that large banks maintain capital that not only surpasses that of smaller regional and local banks, but also is proportionally larger than the bank's slice of the financial pie. Additionally, requiring such hefty reserves could discourage banks from becoming "too big to fail," the researchers write.
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