Andrew G Haldane: The $ billion question Comments by Mr Andrew G Haldane, Executive Director, Financial Stability, Bank of England, at the Institute of Regulation & Risk, Hong Kong, 30 March 2010. *  *  *  I am grateful to Dele Adeleye, David Aikman, Marnoch Aston, Richard Davies, Colm Friel, Vaiva Katinaite, Sam Knott, Priya Kothari, Salina Ladha, Colin Miles, Rhiannon Sowerbutts and Aron Toth for comments and contributions. The car industry is a pollutant. Exhaust fumes are a noxious by-product. Motoring benefits those producing and consuming car travel services – the private benefits of motoring. But it also endangers innocent bystanders within the wider community – the social costs of exhaust pollution. Public policy has increasingly recognised the risks from car pollution. Historically, they have been tackled through a combination of taxation and, at times, prohibition. During this century, restrictions have been placed on poisonous emissions from cars – in others words, prohibition. This is recognition of the social costs of exhaust pollution. Initially, car producers were in uproar. The banking industry is also a pollutant. Systemic risk is a noxious by-product. Banking benefits those producing and consuming financial services – the private benefits for bank employees, depositors, borrowers and investors. But it also risks endangering innocent bystanders within the wider economy – the social costs to the general public from banking crises. Public policy has long-recognised the costs of systemic risk. They have been tackled through a combination of regulation and, at times, prohibition.

40 The number of relationships humans are felt able to maintain is believed to lie below 150 – so-called Dunbar’s Law. 41 For most of us, it is singledigits. That number has been roughly the same since the dawn of time, despite the extraordinary recent advance of technology and social networks. As Nicholas Christakis has observed, Facebook “friends” are not really your friends. With hindsight, this crisis has provided many examples of failures rooted in an exaggerated sense of knowledge and control. Risks and counterparty relationships outstripped banks’ ability to manage them. Servers outpaced synapses. Large banks grew to comprise several thousand distinct legal entities. When Lehman Brothers failed, it had almost one million open derivatives contracts – the financial equivalent of Facebook friends. Whatever the technology budget, it is questionable whether any man’s mind or memory could cope with such complexity. To sum up, the maximum efficient scale of banking could be relatively modest. Perhaps it lies below $ billion. Experience suggests there is at least a possibility of diseconomies of scale lying in wait beyond that point. Conglomerate banking, while good on paper, appears to be more mixed in practice. If these are not inconvenient truths, they are at least sobering conjectures. They also sit awkwardly with the current configuration of banking. In 2008, 145 banks globally had assets above $ billion, most of them universal banks combining multiple business activities. Together, these institutions account for 85% of the assets of the world’s top 1000 banks ranked by Tier 1 capital.