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The financial sector is shrinking. The latest sign is the likely withdrawal of Swiss bank UBS from its fixed income trading business, a decision expected to be announced on Oct. 30. The move would be tough on employees and may be costly for shareholders in the short term. But most of the rest of the world should be glad.

The increase of debt within the financial sector – financial institutions lending to and trading with each other – accounted for about half of the credit bubble. In the United States, the ratio of such financial sector debt to GDP increased by 97 percentage points from 1983 to 2008, to 122 per cent of GDP.

Some of the increase in financial activity may have served the economic good. But any gains in efficiency of capital allocation were dwarfed by the income extracted by well-paid traders and bank shareholders. There was also a drain of talent towards the financial sector. Most seriously, when the credit bubble burst, the losses on financial debt at hugely leveraged financial institutions brought about the deepest and most durable recession in decades.

Prodded by regulatory demands for higher capital and shareholder demands for less risk, the financial sector has made good progress on deleveraging. UBS's restructuring is a particularly dramatic step, but a long series of portfolio reductions throughout the industry have brought the U.S. ratio of financial sector debt to GDP down to 88 per cent, about the level of 2001. In the rest of the economy, the debt-GDP ratio has actually increased, thanks mostly to government borrowing. The pattern is similar in Europe.

While progress has been made, there is probably still a long way to go. How far? No one can say with certainty how much financial debt is too much, but were the American financial industry to return to its relative economic position of, say, 1990, financial sector debt would need to be cut in half. Headcount and pay levels would presumably also fall significantly. So would the risk of another financial crisis.

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Tickers mentioned in this story

Study and track financial data on any traded entity: click to open the full quote page. Data updated as of 28/03/24 7:00pm EDT.

SymbolName% changeLast
UBS-N
UBS Group Ag ADR
-2.17%30.72

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