Why is the UK banking system so big and is that a problem?

Headnote

* Over the past 40 years the size of the UK banking system has grown dramatically and under plausible assumptions it could continue to grow rapidly.

* This article examines a number of issues related to the size of the UK banking system, including why it is so big and what empirical evidence tells us about the relationship between banking system size and financial stability. This evidence suggests that while size can be important, it is the resilience of the banking system that is key for financial stability.

Overview

Over the past 40 years the size of the UK banking system has undergone a dramatic shift, with total assets rising from around 100% to around 450% of nominal GDP. It is plausible that the UK banking system will continue to grow rapidly.

Though there are a number of ways to define the size of a banking system, on each standard metric the UK banking system is large relative to most other major economies. What also makes the UK banking system stand out is its international nature: not only are foreign banks a particularly large part of the UK banking system, but UK banks have large operations abroad.

Why is the UK banking system so big? One reason is that the wider financial system has benefited from firms and people locating near one another in clusters. Partly as a result, the United Kingdom may be able to provide banking services more efficiently than other countries. In other words, it may have a 'comparative advantage' in international banking services. A first mover advantage may also have played a role: the pre-eminence of the UK financial system can, in part, be traced back to the rise of London as a financial centre in the 18th and 19th centuries. Another possible reason for the size of the UK banking system has been the implicit government subsidy associated with banks that are too big to fail. This can lead to an oversupply of banking services relative to the amount that would be most beneficial for society.

From the Bank of England's perspective, it is important for the Financial Policy Committee and Prudential Regulation Authority to understand how much banking system size matters for financial stability. The empirical analysis in...