Banker Blog #1 What does “too big to fail” mean?

“I hate banks. They do nothing positive for anybody except take care of themselves. They’re first in with their fees and first out when there’s trouble”

Earl Warren, American jurist and politician, who served as the 30th Governor of California and later the 14th Chief Justice of the United States.

I couldn’t disagree with Earl Warren more. Banks provide loans to get businesses off the ground, they give people a place to keep their money other than their mattress, they give people credit and the ability to manage their finances, they work with the police to clamp down on fraud, they work with governments to try and tackle money laundering. I could go on and on.

In the first of a series of blogs on misunderstandings with the banking sector, I wanted to take a break from writing advice to look at “too big to fail” an often used term.

You see it in the news, on internet articles, but what does it really mean?

In the UK we normally refer to the big four, the four largest banks in the country. The Royal Bank of Scotland, HSBC, Lloyds Banking Group and Barclays. It is different in other countries, some may only really have one, others can have hundreds.

Let’s say very broadly they are of roughly equal size, each holding about 25% of the public’s money. Not stock brokers or investment houses, just Joe public and their bank accounts.

If any of these banks were to fail, and the government allowed it to collapse, a quarter of the people would see their savings lost. Imagine the chaos that would plunge the country into. The economy is an interlinked machine, the horror doesn’t end with that. A quarter of the people have less money to spend in restaurants, can’t buy games, can’t buy books, can’t buy cars, so all those industries take a massive hit.  The decline in confidence in the banking sector sees the other 75% of banks struggle against a hesitant public, those failing industries default on their loans and can’t make payments.

A bank of that size collapsing, even one, without exaggeration can ruin a country.

So during the financial crisis of 2008, when some politicians sneered that some banks should be allowed to collapse because there were still others left really didn’t understand the full impact that would have.

That is what too big to fail means. These banks are so gigantic, so totally intertwined with the economy, that if they were to be allowed to fail as a result of their own poor decisions and management, the entire nation would suffer.

No government would allow this to happen for two reasons. Number one, it is safe to say a lot of people in politics do actually care about their fellow citizens. Not all, but a fair amount. They don’t want the people to have to go through that pain. Number two, let’s say you don’t care at all about the suffering of others. Okay, fair enough. But you can kiss re-election goodbye if you allow this to happen, you have to save the bank or your career in the public domain is dead.


  • Financial Services Compensation Scheme

This ensures that up to £85,000 of your savings is guaranteed, even if your bank fails. For some people, this covers their entire savings or at least a majority of it. This means government can be bolder in allowing a bank to fail.

  • Ringfencing

This means that the risky, investment side of banking is broken off from the main bank. This was one of the problems with too big to fail, the folks gambling on the stock market could arrogantly do so because even if they lost all the bank’s money, the government would top it up because if the bank fails, the retail side goes down and people lose their deposits.

Ringfencing breaks it into two. Firstly, the safe, so called “boring” retail and commercial side of banking, focusing on bank accounts, deposits, lending to people and companies (where yours truly earns his daily bread). Secondly, the risky, stock market wheeling and dealing, high risk investments.

So if the investment bankers decide to go crazy, their organisation is separate from the main bank and can be allowed to fail without impacting the public.

  • Force the big four to break up

I disagree with this solution but I have seen it bandied around, most prominently in the run up to the last election, with Labour leader Ed Miliband touting it. Not as disastrous as the Ed Stone (  but not one of this better ideas.

I fear that forcing in organisation to break into ten separate entities could result in several underfunded, undercapitalised and underprepared banks trying desperately to stay afloat and most likely failing.

I haven’t seen any concrete or well articulated reason why this would work yet so I don’t support it.


What to take from this blog?

Too big to fail is not a permanent part of banking, it is actually a fairly recent phenomenon, brought to a head in 2008 after a period of insane growth driven off subprime mortgages at the height of an investment bubble.

Despite what some commentators may say, It is not a permanent addition to the banking world and  steps have already been taken to ensure that if a bank makes poor choices, it is allowed to collapse, as it should.


Further reading

Too big to fail by Andrew Sorkin

Shredded: Inside RBS the bank that broke Britain by Ian Fraser

Hubris: How HBOS wrecked the best bank in Britain by Ray Perman

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