Yesterday, the U.S. Big Banking Cartel announced its intention to provide $30 billion in unsecured deposits to First Republic, an action without precedent in their history.  This brings to the fore the issue of TBTF — Too Big To Fail financial and other institutions.

Since the global financial crisis, this has morphed into the term SIFI, Systemically Important Financial Institutions, with lists compiled at the national level by financial regulators and at the international level by the Bank for International Settlements (BIS).  There are 30 G-SIBs, or Globally Systematically Important Banks, including eight from the U.S.  In addition, there are 22 U.S. D-SIBs, or Domestically Systematically Important Banks.  In the U.S., the the Financial Stability Board (FSB) monitors divides them into five groups, each requiring a specific level of additional loss absorbency.  The Fed also operates the LISCC, the Large Institution Supervisory Coordinating Committee.

By its initiative, the U.S. Big Banking Cartel has signaled that it faces a threat to its liquidity, solvency, and even survival that is outside the regulatory framework in place and is as unlikely to be contained by the Fed as the recent runaway inflation has been.  The crux of the difficulty is that unimaginable sums of notional derivatives  are outside meaningful regulatory supervision, which is the way banks prefer.  Derivative contracts are often voluminous and idiosyncratic, and a failure can be followed by years of litigation and financial uncertainty.  The failure by a counterparty can result in a chain reaction of other failures in a domino effect.  Even if financial regulators had access to the underlying data, it would not be possible to quantify their effect on loss absorbency by any single institution without speculative assumptions.

The top five banks have reported notional derivatives at the end of 2022 of over $180 trillion.  For comparison of scale, this is almost double the International Monetary Fund's estimate of global GDP for that year.  The trading of derivatives far exceeds the trading of legacy markets such as equities, bonds, and corporate and other debt, and the big banks depend on its revenue more than on legacy banking services.  First Republic had reported only a little more than $8 billion in notional derivatives, a drop in the bucket.  The risk from its potential failure was contagion, perhaps tainting its San Francisco neighbors, undergoing some scrutiny of its reputation, and holding notional derivatives in excess of $12 trillion.  And so the Big Banking Cartel, not known for altruistic business decisions, has stepped forward to lodge fingers in the dike.

Not to worry — the Fed has the rear view in its gaze and is beginning an inquiry into the string of recent bank failures.  If mirrors were not in short supply within the nation's capital, they might have some chance of finding the culprit.

Image: Library of Congress.