The practice of banking:  For almost a century after Bagehot wrote Lombard Street, the size of the banking sector in the UK, relative to GDP, was broadly stable at around 50%. But, over the past fifty years, bank balance sheets have grown so fast that today they are over five times annual GDP. The size of the US banking industry has grown from around 20% in Bagehot’s time to around 100% of GDP today. And, until recently, the true scale of balance sheets was understated by these figures because banks were allowed to put exposures to entities such as special purpose vehicles off balance sheet. Surprisingly, such an extraordinary rate of expansion has been accompanied by increasing concentration: the largest institutions have expanded the most. Table 1 shows that the asset holdings of the top ten banks in the UK amount to over 450% of GDP, with RBS, Barclays  BIS Review 140/2010  1  and HSBC each individually having assets in excess of UK GDP. Table 2 shows that in the US, the top ten banks amount to over 60% of GDP, six times larger than the top ten fifty years ago. Bank of America today accounts for the same proportion of the US banking system as all of the top 10 banks put together in 1960. While banks’ balance sheets have exploded, so have the risks associated with those balance sheets. Bagehot would have been used to banks with leverage ratios (total assets, or liabilities, to capital) of around six to one.
Change is, I believe, inevitable. The question is only whether we can think our way through to a better outcome before the next generation is damaged by a future and bigger crisis. This crisis has already left a legacy of debt to the next generation. We must not leave them the legacy of a fragile banking system too. I have explained the principles on which a successful reform of the system should rest. It is a program that will take many years, if not decades. But, as Bagehot concluded in Lombard Street, “I have written in vain if I require to say now that the problem is delicate, that the solution is varying and difficult, and that the result is inestimable to us all.” References Admati, A.R., DeMarzo, P.M., Hellwig, M.F., and Pfleiderer, P (2010), “Fallacies, Irrelevant Facts, and Myths in the Discussion of Capital regulation: Why Bank Equity is Not Expensiv” Stanford Business School, mimeo. Arrow, K.J. (1951), “An extension of the basic theorems of classical welfare economics”, In Proceedings of the Second Berkeley Symposium on Mathematical Statistics and Probability, ed. J. Neyman, Berkeley: University of California Press, 507–32. Arrow, K.J. and Debreu, G. (1954) “Existence of an equilibrium for a competitive economy”, Econometrica 22, 265–90. Bagehot, W. (1873), “Lombard Street: A Description of the Money Market”, Wiley & Sons, (reprinted 1999).