Recent announcement by the US president to put a cap on the size of the bank to avoid any more financial meltdowns
What has happened in the past?
The banks had entered into high risk market.
The bad debts rose and as a result there were many write-offs.
To prevent a meltdown of the financial system, the US Government decided to help these banks by giving them financial aid to recover.
In simple terms, the US Fed printed more money and also asked the entire world to do so. (This is a big debate by itself)
This move by the Fed lifted the money that is floating in the market, but this time keeping a strict vigilance on the banks (as to how credit worthy were the lenders).
What is the
It is planning to limit the size of the bank not to grow too big so that it starts to take too much risk to become more profitable.
This move is in fact a very good move because of the following reasons:
1. The risk appetite of the financial giants might go unnoticed when the size is too big. Now with smaller market cap it can be monitored and regulated effectively.
2. Smaller the upper limit more will be the participants and more will be the competition. This will benefit the end user, the borrower in terms of lower rates.
3. When the banks/financial institution have an upper threshold in size, it will be made to disintegrate into different units in the long run. In the process, the non-performing entities are closed down right at the initial stage instead of letting it grow into a monster. This will lead to more merger and acquisitions and at the same time healthier disintegration (re-organization) after the size has achieved the threshold.
4. Supervision and control becomes easier when the size is small.
Any such action might also have some disadvantages:
1. There can be too much competition that the profit margins start to decline. This will have a big impact on the big packet salaries of the investment managers.
2. There can be too much lobbying to favor a restructuring for certain firms that the others stand to loose.
I am not successful in listing the disadvantages for this well intended step, but what I feel is that the market is just offering resistance to any change which is an immature reaction. I am surprised to see fundamentalists outnumbered by technical traders.
