Holding back evolution March 30, 2012 at 7:26 am
Hans asked a good question in comments to a prior post:
when you start off with 40 medium size banks, eventually a few will have a better business model than the others. And then the business model gets copied (due to shareholders seeing the return at the more successful banks and wanting the same) which leads to a convergence to 40 banks with (more or less) the same business model. Basically what we saw in the run-up to the financial crisis. After which the take-overs can begin due to economy of scale.
In other words: I agree that ‘evolution’ thrives on diversity, but how do you prevent convergence to one (or 2/3) business models?
I have to say that that one has me stumped for now. The fitness landscape changes fast for banks, so rapid change (what an evolution biologist would call Saltation) is the norm. If we let evolutionary pressure bear on a diverse set of creatures in a fitness landscape with a single peak – a single business model – the ones that don’t climb the peak aren’t very successful. So do we have to imagine legislators coming in like comets every 50 years and imposing diversity again? That’s pretty depressing.
The problem is the premise: a single-peaked fitness landscape. Diversity is encouraged when there are lots of local maxima in the fitness landscape. We need, in other words, to make sure that lots of banking different models are acceptably profitable. There are two ways to do this of course: lifting up the little guys (aka the wildlife sanctuary approach) or crushing the big guys (aka a cull). To your elephant guns, gentlemen.