## _sdn1112 - EXECUTIVE SUMMARY

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---

### Executive summary and policy objectives
- The recent financial crisis underscored the too-important-to-fail (TITF) problem associated with systemically important financial institutions (SIFIs): implicit government backing permitted greater risk taking and a competitive advantage, and scale, complexity, and interconnectedness made some SIFIs too significant to permit failure.
- Post-crisis observations:
  - Some SIFIs have become bigger and more complex.
  - Risky lending practices have reappeared.
  - Restructuring increased concentration in many advanced economies’ financial systems.
- Policy objectives:
  - Make financial institution failures less likely and less devastating when they occur.
  - Reestablish market discipline and level the playing field.
  - Spare governments and taxpayers the costs of future bailouts.
- Final executive-statistics highlight:
  - Direct support during the crisis: estimated at 6.4 percent of GDP on average in the most crisis-affected countries at end-2010.

### Core elements of an adequate TITF policy framework
- Key components:
  - More stringent capital (and possibly liquidity) requirements to limit contribution to systemic risk.
  - Intensive supervision consistent with SIFIs’ complexity and riskiness.
  - Enhanced transparency and disclosure to capture emerging risks in the broader financial system.
  - Effective resolution regimes at national and global levels, with resolution plans/tools that lead creditors to share any losses.
- Reinforcing actions to limit unintended consequences:
  - Better policing of firewalls between regulated and unregulated segments and enhanced disclosure for the shadow banking system.
  - Effective cross-border arrangements for supervisory cooperation and information- and burden-sharing between home and host authorities.
  - Realigning management incentives with the banking group to contain risk-taking incentives.
- Transition urgency and interim action:
  - Implementation of the building blocks could take several years.
  - Rapid progress required on: methodology (and scope of application) to identify SIFIs; the level, composition, and coverage of a capital surcharge; institutionalizing international standards for intensive supervision of SIFIs and translating them into national practices; enhancing disclosure, addressing data gaps, understanding shadow banks, and achieving consensus on cross-border resolution and information- and burden-sharing arrangements.
  - Interim credible action: coordinated transitional measures to avoid disparate national frameworks becoming locked in, in particular requiring SIFIs to hold significantly more loss-absorbing capital combined with enhanced supervision during the transition.

### I. Introduction and background
- Moral hazard and market perception:
  - SIFIs viewed as TITF may be allowed by markets to take greater risks because creditors (and sometimes rating agencies) may not price full credit risk.
  - TITF status leads to a funding advantage and competitive advantage facilitating further expansion, and to political influence over regulatory and legislative processes.
- Cross-border and systemic footprint:
  - Cross-border interconnectedness increased the systemic footprint of a relatively small number of large, complex institutions.
  - Lack of transparency and limited disclosure made exposures and spillovers difficult to assess.
- Regulatory and supervisory shortfalls:
  - Regulatory, supervisory, and resolution frameworks and bank risk-management systems did not keep pace with changes in scale, complexity, and cross-border activity.
  - Crisis support (direct or via guarantees) reinforced perceptions of TITF status and may have increased SIFIs’ funding advantage; some banks became even bigger due to exit of competitors and government-assisted mergers and acquisitions.

### II. The TITF problem and stylized facts
- Benefits and risks of large, complex institutions:
  - Benefits: diversification and scale up to some threshold; facilitation of cross-border capital flows; provision of unique essential functions (payments, settlements, clearing).
  - Risks: capacity to spread distress due to scale, essential functions, and interlinkages; complexity and multi-jurisdictional legal structures hinder management, supervision, and resolution.
- Distortions documented:
  - Funding advantage and competitive advantage: Figure 1 documents that largest U.S. banks borrowed at lower rates than smaller banks and the advantage widened after the crisis.
  - Political ties and regulatory influence.
- Evolution and concentration (sample findings):
  - Sample: 84 banks domiciled in Europe, the western hemisphere, and Asia considered systemic at national, regional, or global levels.
  - Their share of assets doubled during 2000-09, reaching about a quarter of the total; total assets grew significantly and outpaced the rest of the financial system in many instances.
  - Growth drivers: expansion of securities portfolios and mergers and acquisitions.
  - In 2009, an institution in the top quartile of the distribution by size (total assets ranging from $50 billion to $3,000 billion) was, on average, about five times larger than the average institution in the rest of the sample.
  - No complete overlap between largest, most interconnected, and least substitutable institutions—size alone does not capture all TITF dimensions.
  - Very large and highly interconnected institutions tend to have significant cross-border activities.
- Distress and policy response correlations:
  - Institutions more interconnected had a higher likelihood of distress during the recent crisis than other financial institutions; frequency of distress was notably higher for banks with investment and universal banking activities than for commercial banks.
  - The size of an institution relative to home country GDP or relative to the financial system played a key role in authorities’ decisions to bail it out. Logit regressions show a robust, statistically significant relationship between probability of official support (given distress) and a distressed bank’s size relative to GDP and between probability of distress and degree of interconnectedness.
- Crisis concentration metrics:
  - Share of the 10 largest global banks: 14 percent in 1999, 19 percent in 2007, and 26 percent in 2009.
  - U.S. specifics: JP Morgan Chase holds more than 10 percent of deposits in the United States; JP Morgan Chase, Bank of America (after acquisition of Merrill Lynch), Wells Fargo (after acquisition of Wachovia), and Citigroup together issue half of all mortgages and two–thirds of all credit cards, and held 34 percent of all bank deposits in the United States in 2009; the largest U.S. derivatives dealers account for 37 percent of global notional outstanding amount of derivatives, and the 14 largest global derivatives dealers hold 82 percent.

### III. Will the current policy proposals resolve the TITF problem?
- Reform context:
  - Reforms aim to promote a less leveraged, less risky financial system and to prevent repeat crises and taxpayer-funded bailouts.
  - Basel Committee measures (Basel III) aim to strengthen capital and liquidity buffers, improve loss absorption, better recognize counterparty/market risk, introduce simple capital-to-asset leverage ratio, and tighter liquidity standards.
- Shortcomings of firm-level strengthening:
  - Strengthening individual banks’ balance sheets is necessary but likely insufficient; a framework must account for system-wide interactions and externalities SIFIs generate.
- Three complementary policy objectives:
  - Directly reduce systemic risk of institutions.
  - Reduce the probability of SIFI failure.
  - Construct a resolution framework to resolve failed financial institutions with minimal systemic disruption.
- Mutually reinforcing components of an effective framework:
  - Structural measures to limit size and scope of activities.
  - Regulations including surcharges reflecting an institution’s contribution to systemic risk.
  - Enhanced transparency and disclosure.
  - Proactive and intensive supervision commensurate with complexity and systemic risk.
  - Effective resolution framework with tools to enhance resolvability, including living wills.
  - Effective private-sector burden-sharing to internalize losses by creditors and shareholders.

### B. Structural measures to address TITF
- Measures to limit size and scope:
  - Options: caps on future growth, asset sales, break-ups.
  - Dodd-Frank provision: U.S. regulators may prohibit mergers if consolidated liabilities of the resulting institution constitute more than 10 percent of the aggregate consolidated liabilities of the whole financial system.
  - Scope restrictions examples: separating deposit-funded banks from private-sector lending/investment banking; ring-fencing retail banking from wholesale/investment banking; Volcker Rule restricting proprietary trading and investment in/sponsorship of hedge and private equity funds; U.S. Swap Push-out Rule requiring certain entities move swap activity to separately capitalized nonbank affiliates.
- Implementation challenges:
  - Opponents argue these are retrograde and could hinder innovation and development.
  - No international support for size caps (other than EC state aid rules); evidence on scale economies is mixed.
  - Limits on bank scope may cause risky activities to migrate to less regulated parts of the financial system unless accompanied by wider reporting/regulation and intensified supervision of nonbanks.
- Organizational-structure measures:
  - Favoring subsidiaries over branches can achieve local self-sufficiency and simplify resolution.
  - Subsidiary structures can make it easier to spin off businesses and implement living wills, but imposing a single organizational form can be costly and eliminate advantages of alternative structures.

### C. Measures to reduce the probability and impact of failures
- Capital surcharges:
  - A systemic-risk-based capital surcharge over and above Basel minimums is being considered to increase capital buffers and loss-absorbency.
  - Country examples:
    - Switzerland proposed a 19 percent capital-to-risk-weighted asset requirement—with 10 percent common equity Tier 1—for its two largest banks.
    - U.K. IBC proposed a 10 percent common equity Tier 1 ratio for retail banking operations.
  - Design challenges: requires methodologies to measure aggregate system risk and spillovers; surcharges could be smoothed and calibrated to rise with systemic importance and adjusted for ease of resolution.
  - Eligible instruments: primarily common equity, with some portion possibly met by contingent convertible capital (CoCo).
- Contingent capital (CoCo):
  - Can automatically increase equity or reduce debt upon a predetermined trigger; triggers set high can function as prevention, triggers set low can aid orderly resolution; conversion may enhance market discipline by creating a credible threat of losses to creditors.
- Systemic liquidity charges:
  - BCBS new liquidity standards raise individual liquidity buffers and reduce maturity mismatches but are not designed to mitigate systemic liquidity risk (collective under-pricing of liquidity risk).
  - IMF (2011) suggests three potential measures for systemic liquidity risk measurement to inform macroprudential tools.
- Levies and taxes:
  - Levies or deposit insurance premiums could discourage excessive risk-taking and finance resolution costs.
  - Country examples of actions: bank levies in France, Germany, Hungary, Sweden, and the United Kingdom; risk-based deposit insurance premiums in the United States.
  - Design caveat: levies should be linked to a credible resolution mechanism to avoid perceptions that paying institutions will not be allowed to fail; levies complement but do not substitute for higher capital.
- More intensive and proactive supervision:
  - Failures in governance, risk management, and information systems impeded risk identification and timely intervention.
  - Supervisory needs for SIFIs:
    - Mandate, resources, and operational independence.
    - Full powers and political backing for early intervention.
    - Supervisory approaches/techniques reflecting financial system complexity.
    - Higher supervisory standards for SIFIs; establishment of supervisory colleges and FSB peer review process.
  - Supervisory effectiveness requires political backing and resources; alignment of compensation incentives as per FSB recommendations is important.
- Enhanced transparency and disclosure:
  - Market discipline requires routine, timely, and accurate disclosure of exposures, off-balance-sheet items, complex products, interconnectedness, and cross-border exposures.
  - Key data gaps: sectoral, market, and cross-border exposures; off-balance-sheet items; extent of interconnectedness; financial stability indicators; OTC derivative market transparency.
  - Agreement reached on a data template for global SIFIs; should be extended to all SIFIs.
- Resolution frameworks and resolvability:
  - Essential to make orderly resolution feasible without systemic disruption, moral hazard, or taxpayer losses.
  - FSB recommendations (with Fund coordination) focus on:
    - Effective resolution regimes and tools (legal reforms, resolution authority with tailored powers).
    - Effective cross-border coordination mechanisms.
    - Mandatory recovery and resolution planning (RRPs, living wills) for G-SIFIs.
  - National progress examples:
    - U.S. Dodd-Frank “Orderly Liquidation Authority”.
    - New regimes in Belgium, Germany, Sweden, Switzerland, United Kingdom.
    - EC proposals for RRPs and powers to transfer failing bank business to bridge banks.
  - Cross-border progress is limited: differences in national frameworks, absence of mutual recognition, lack of home-host burden-sharing arrangements, and legal/operational impediments hinder cross-border orderly resolution.
  - IMF interim proposal: amend national laws to remove legal impediments to international cooperation and allow only countries satisfying core coordination standards to participate; standards include harmonized resolution laws, rescinding discriminatory national legislation, effective resolution tools and creditor safeguards, strengthened regulatory cooperation, and enhanced authority capacity.
  - RRPs (living wills): recovery plan by firm and resolution plan by authorities; provide essential information on assets, liabilities, exposures, and legal/operational structure; implementation may face challenges due to complexity, reputational effects during distress, and the need for cross-border cooperation.
- Effective burden-sharing with the private sector:
  - Bail-inable debt or bail-in statutory powers can convert private debt into equity to provide loss-absorbing capacity during stress, increasing market discipline and reducing taxpayer exposure.
  - Bail-in tools give resolution authorities statutory means to write down debt or convert debt to equity as part of restructuring.

### Box 1. Bail-inable Debt Proposals (summary)
- Concept and intended role:
  - Bail-in proposals are being considered as a market-based tool to address moral hazard risks associated with SIFIs.
  - Objective: to incentivize institutions to raise capital or to restructure debt voluntarily before a triggering of the bail-in power.
  - General features: statutory approach to debt write-downs and debt-equity conversion; power to add to capital base via regulatory intervention while the institution is operating under official administration (conservatorship); preserve traditional priority of claims in liquidation; prospect of conversion may add to market discipline.
  - Jurisdictional interest: regulators in several countries (Canada, the United States, and others in Europe) have shown interest; concept, scope, and role are under discussion within the Basel Committee, FSB, and EU.
  - Basel Committee minimum requirement noted: issued on January 13, 2011, to ensure that all classes of capital instruments fully absorb losses at the point of nonviability before taxpayers are exposed to loss.
- Legal, cross-border, and scope considerations:
  - Statutory bail-in must be carefully elaborated to reduce legal uncertainty because creditors would be forced to give up full legal claims upon the trigger event.
  - Potential conflicts with laws that guarantee property rights if bail-in is applied retroactively or without explicit terms and conditions built into the investment recognizing authorities’ rights for debt write-off or conversion at point of nonviability.
  - Effectiveness depends crucially on recognition within all relevant jurisdictions; international coordination is important to preserve a level playing field and avoid unintended consequences for bank debt markets.
  - Scope guidance: in principle, deposits, secured claims, and qualified financial contracts should be excluded from the scope of debt subject to bail-in.
- Design and financial-stability risks:
  - Bail-in instruments should not be a stand-alone tool; they should be accompanied by strengthened supervision, an enhanced capital base, improved disclosure, and an effective resolution regime.
  - Risks and uncertainties: triggering bail-in could send negative market signals and destabilize markets during times of high market volatility and uncertainty; marketability of instruments subject to bail-in is uncertain given potential discretionary elements and investors’ lack of familiarity; careful monitoring by supervisory authorities of implied transfer of risks within the financial system and potential build-up of systemic risks will be important.
  - There may be a case for restricting some holders of convertible instruments to limit contagion effects across SIFIs.
  - Ensuring consistency, transparency, and standardization is important to avoid complex structures and support cross-border crisis management.

### Conclusions and policy implications
- Overarching principle:
  - No private financial institution should be viewed by markets as being too important to be allowed to fail.
- Mutually reinforcing core policies to internalize risks and limit negative externalities:
  - Materially more stringent capital requirements (and possibly liquidity requirements as appropriate methodologies are developed), designed to reduce the probability of failure and to limit systemic risk contributions.
  - Intensive and proactive supervision commensurate with their complexity and risks.
  - Enhanced transparency and disclosure requirements for early identification of risks.
  - Effective resolution regimes at the national and global level to make resolution a credible, feasible, and viable option in the event of nonviability.
- Supporting elements to reinforce effectiveness and limit unintended consequences:
  - Better policing of firewalls and links between regulated and unregulated sectors and enhanced disclosure requirements for the nonbank sector to limit indirect risk retention and relocation of systemic risk.
  - Improved understanding of the shadow banking system to prevent unregulated nonbank institutions from gaining systemic importance.
  - Effective cross-border arrangements for cooperation, information-sharing, and funding to facilitate cross-border resolution and limit regulatory arbitrage in the absence of harmonized SIFI measures.
  - Management incentives realigned (for example, through effective compensation policies linked to better and sound performance) to limit incentives for excessive risk-taking.
- Outstanding and complex issues requiring tangible progress:
  - Finalizing the methodology (and scope of application) to identify SIFIs.
  - Determining the level, composition, and coverage of a capital surcharge.
  - Institutionalizing international standards and translating recommendations for intensive supervision of SIFIs into national practices.
  - Addressing data gaps.
  - Agreeing on cross-border resolution arrangements.
  - Making visible progress in reforming compensation policies to align compensation structures with prudent risk-taking, along the lines recommended by the FSB.
- Transitional and interim measures recommended:
  - Implement a subset of simple and straightforward measures internationally on a consistent basis in the interim, including an announcement that SIFIs identified as TITF will be required to hold significantly more high-quality (loss-absorbing) capital than systemically less important institutions.
  - Accelerate adoption of the FSB recommendations for enhanced supervision to reduce the risk that tighter requirements simply relocate systemic risk to affiliates subject to less or no regulation.
  - Apply higher equity capital requirements for SIFIs identified as TITF above Basel III minimums as progress is made on other TITF solution components (such as effective national and cross-border resolution regimes).
  - Provide a reasonable transition period during which undercapitalized banks can build their capital bases to limit risks to the real sector from any reduced availability of credit.
  - Combine higher capital requirements with enhanced supervision to reduce SIFIs’ propensity to accumulate systemic risk.
  - Apply these actions across all major jurisdictions as the transition to full implementation of the TITF framework is achieved.

*Source: IMF staff executive summary from the PDF chapter titled “_sdn1112 - EXECUTIVE SUMMARY.”*

### Executive Summary ......................................................................................................

### Executive Summary

### I. Introduction and Background
- Section located on page 3.

### II. The TITF Problem and Some Stylized Facts
- Section located on page 5.
- Figures related to this section:
  - Figure 1. U.S. Financial Institutions: Bigger Borrows Cheaper
  - Figure 2. The Big Grow Bigger
  - Figure 3. Frequency of Distress for Different Types of Institutions

### III. Will the Current Policy Proposals Resolve the TITF Problem?
- Section located on page 9.
- Figure related to this section:
  - Figure 4. Likelihood of Official Support, Given Distress, for Different Types of Institutions

#### A. How Should the TITF Problem be Addressed?
- Subsection located on page 10.
- Figure related to this subsection:
  - Figure 5. Dealing with the Risks Posed by Systemically Important Financial Institutions Beyond Basel III

#### B. Structural Measures to Address the TITF Problem
- Subsection located on page 11.

#### C. Measures to Reduce the Probability and Impact of Failures
- Subsection located on page 13.

### IV. Conclusions and Policy Implications
- Section located on page 21.

### Figures (list and placement)
- Figure 1. U.S. Financial Institutions: Bigger Borrows Cheaper (page 6)
- Figure 2. The Big Grow Bigger (page 7)
- Figure 3. Frequency of Distress for Different Types of Institutions (page 8)
- Figure 4. Likelihood of Official Support, Given Distress, for Different Types of Institutions (page 9)
- Figure 5. Dealing with the Risks Posed by Systemically Important Financial Institutions Beyond Basel III (page 10)
- Figure 6. Distribution of Banks by Business Model and Scale of Cross-border Activities (page 25)
- Figure 7. Number of Banks in the Top Quartiles of the Distributions by Absolute Size, Interconnectedness, and Substitutability (page 26)
- Figure 8. Distribution of Banks by Size and Interconnectedness Quartiles, and by Business Model and Region (page 27)

### Box
- Box 1. Bail-inable Debt Proposals (page 20)

### Appendixes
- Appendix I. Is Big Beautiful? Evidence on the Economies of Scale/Scope and Diversification Benefits of Financial Conglomerates (page 23)
- Appendix II. Sample Description (page 25)

### References
- References section (page 28)

*Source: Executive Summary (pages as listed) from the provided PDF content.*

### EXECUTIVE SUMMARY

### _sdn1112 - EXECUTIVE SUMMARY

### Executive summary and policy objectives
- The recent financial crisis underscored the too-important-to-fail (TITF) problem associated with systemically important financial institutions (SIFIs): implicit government backing permitted greater risk taking and a competitive advantage, and scale, complexity, and interconnectedness made some SIFIs too significant to permit failure.
- Post-crisis: some SIFIs have become bigger and more complex; risky lending practices have reappeared; restructuring increased concentration in many advanced economies’ financial systems.
- Policy objectives:
  - Make financial institution failures less likely and less devastating when they occur.
  - Reestablish market discipline and level the playing field.
  - Spare governments and taxpayers the costs of future bailouts.

### Core elements of an adequate TITF policy framework
- Key components:
  - More stringent capital (and possibly liquidity) requirements to limit contribution to systemic risk.
  - Intensive supervision consistent with SIFIs’ complexity and riskiness.
  - Enhanced transparency and disclosure to capture emerging risks in the broader financial system.
  - Effective resolution regimes at national and global levels, with resolution plans/tools that lead creditors to share any losses.
- Reinforcing actions to limit unintended consequences:
  - Better policing of firewalls between regulated and unregulated segments and enhanced disclosure for the shadow banking system.
  - Effective cross-border arrangements for supervisory cooperation and information- and burden-sharing between home and host authorities.
  - Realigning management incentives with the banking group to contain risk-taking incentives.

### Transition and implementation urgency
- Implementation of the building blocks could take several years.
- Rapid progress required on a number of complex issues:
  - The methodology (and scope of application) to identify SIFIs.
  - The level, composition, and coverage of a capital surcharge.
  - Institutionalizing international standards for intensive supervision of SIFIs and translating them into national practices.
  - Enhancing disclosure, addressing data gaps, understanding shadow banks, and achieving consensus on cross-border resolution and information- and burden-sharing arrangements.
- Interim credible action:
  - Coordinated transitional measures are needed to avoid disparate national frameworks becoming locked in.
  - In particular, require SIFIs to hold significantly more loss-absorbing capital combined with enhanced supervision during the transition.

### Final executive-statistics highlight
- Direct support during the crisis: estimated at 6.4 percent of GDP on average in the most crisis-affected countries at end-2010.

---

### I. Introduction and background
- Moral hazard: SIFIs viewed as TITF may be allowed by markets to take greater risks because creditors (and sometimes rating agencies) may not price full credit risk.
- TITF status leads to:
  - Lower cost of funds and funding advantage over smaller institutions.
  - Competitive advantage facilitating further expansion.
  - Political influence over regulatory and legislative processes.
- Cross-border interconnectedness increased the systemic footprint of a relatively small number of large, complex institutions; lack of transparency and limited disclosure made exposures and spillovers difficult to assess.
- Regulatory, supervisory, and resolution frameworks and bank risk-management systems did not keep pace with changes in scale, complexity, and cross-border activity.
- Crisis support (direct or via guarantees) reinforced perceptions of TITF status and may have increased SIFIs’ funding advantage; some banks became even bigger due to exit of competitors and government-assisted mergers and acquisitions.

---

### II. The TITF problem and stylized facts
- Benefits and risks of SIFIs:
  - Benefits: diversification and scale up to some threshold, facilitation of cross-border capital flows, some provide unique essential functions (payments, settlements, clearing).
  - Risks: capacity to spread distress due to scale, essential functions, and interlinkages; complexity and multi-jurisdictional legal structures hinder management, supervision, and resolution.
- Distortions from TITF status:
  - Funding advantage and competitive advantage over less important institutions (Figure 1: largest U.S. banks borrowed at lower rates than smaller banks and the advantage widened after the crisis).
  - Political ties and regulatory influence.
- Evolution and concentration:
  - Sample of 84 regionally diverse banks shows: their share of assets doubled during 2000-09, reaching about a quarter of the total; total assets grew significantly and outpaced the rest of the financial system in many instances.
  - Growth drivers: expansion of securities portfolios and mergers and acquisitions.
- Sample-specific statistics and observations:
  - Sample: 84 banks domiciled in Europe, the western hemisphere, and Asia considered systemic at national, regional, or global levels.
  - In 2009, an institution in the top quartile of the distribution by size (total assets ranging from $50 billion to $3,000 billion) was, on average, about five times larger than the average institution in the rest of the sample.
  - No complete overlap between largest, most interconnected, and least substitutable institutions—size alone does not capture all TITF dimensions.
  - Very large and highly interconnected institutions tend to have significant cross-border activities.
  - Institutions more interconnected had a higher likelihood of distress during the recent crisis than other financial institutions; frequency of distress was notably higher for banks with investment and universal banking activities than for commercial banks.
  - The size of an institution relative to home country GDP or relative to the financial system played a key role in authorities’ decisions to bail it out. Logit regressions show a robust, statistically significant relationship between probability of official support (given distress) and a distressed bank’s size relative to GDP and between probability of distress and degree of interconnectedness.
- Crisis concentration metrics (reported in text):
  - Share of the 10 largest global banks: 14 percent in 1999, 19 percent in 2007, and 26 percent in 2009.
  - Example concentration specifics for U.S. institutions: a combination of mergers produced institutions such that JP Morgan Chase holds more than 10 percent of deposits in the United States; JP Morgan Chase, Bank of America (after acquisition of Merrill Lynch), Wells Fargo (after acquisition of Wachovia), and Citigroup together issue half of all mortgages and two–thirds of all credit cards, and held 34 percent of all bank deposits in the United States in 2009; the largest U.S. derivatives dealers account for 37 percent of global notional outstanding amount of derivatives, and the 14 largest global derivatives dealers hold 82 percent.

---

### III. Will current policy proposals resolve the TITF problem?
- Reform context:
  - Reforms aim to promote a less leveraged, less risky financial system and to prevent repeat crises and taxpayer-funded bailouts.
  - Basel Committee measures (Basel III) aim to strengthen capital and liquidity buffers, improve loss absorption, better recognize counterparty/market risk, introduce simple capital-to-asset leverage ratio, and tighter liquidity standards.
- Shortcomings of firm-level strengthening:
  - Strengthening individual banks’ balance sheets is necessary but likely insufficient; a framework must account for system-wide interactions and externalities SIFIs generate.
- Policy approaches (three complementary objectives):
  - Directly reduce systemic risk of institutions.
  - Reduce the probability of SIFI failure.
  - Construct a resolution framework to resolve failed financial institutions with minimal systemic disruption.

- Components of an effective framework (mutually reinforcing):
  - Structural measures to limit size and scope of activities.
  - Regulations including surcharges reflecting an institution’s contribution to systemic risk.
  - Enhanced transparency and disclosure.
  - Proactive and intensive supervision commensurate with complexity and systemic risk.
  - Effective resolution framework with tools to enhance resolvability, including living wills.
  - Effective private-sector burden-sharing to internalize losses by creditors and shareholders.

B. Structural measures
- Measures to limit size and scope:
  - Options: caps on future growth, asset sales, break-ups.
  - Dodd-Frank: empowers U.S. regulators to cap size by prohibiting mergers if consolidated liabilities of the resulting institution constitute more than 10 percent of the aggregate consolidated liabilities of the whole financial system.
  - Scope restrictions: separating deposit-funded banks from private-sector lending/investment banking; ring-fencing retail banking from wholesale/investment banking; Volcker Rule restricting proprietary trading and investment in/sponsorship of hedge and private equity funds; U.S. Swap Push-out Rule requiring certain entities move swap activity to separately capitalized nonbank affiliates.
- Implementation challenges:
  - Opponents argue these are retrograde and could hinder innovation and development.
  - No international support for size caps (other than EC state aid rules); evidence on scale economies is mixed.
  - Limits on bank scope may cause risky activities to migrate to less regulated parts of the financial system unless accompanied by wider reporting/regulation and intensified supervision of nonbanks.
- Measures to simplify organizational structures:
  - Some authorities favor subsidiaries over branches to achieve local self-sufficiency and simplify resolution.
  - Subsidiary structures can make it easier to spin off businesses and implement living wills, but imposing a single organizational form can be costly and eliminate advantages of alternative structures.

C. Measures to reduce probability and impact of failures
- Capital surcharges:
  - A systemic-risk-based capital surcharge over and above Basel minimums is being considered to increase capital buffers and loss-absorbency.
  - Country examples: Switzerland proposed a 19 percent capital-to-risk-weighted asset requirement—with 10 percent common equity Tier 1—for its two largest banks; U.K. IBC proposed a 10 percent common equity Tier 1 ratio for retail banking operations.
  - Designing and calibrating surcharges is challenging: requires methodologies to measure aggregate system risk and spillovers; surcharges could be smoothed and calibrated to rise with systemic importance and adjusted for ease of resolution.
  - Eligible instruments: primarily common equity, with some portion possibly met by contingent convertible capital (CoCo).
- Contingent capital (CoCo):
  - Can automatically increase equity or reduce debt upon a predetermined trigger; triggers set high can function as prevention, triggers set low can aid orderly resolution; conversion may enhance market discipline by creating a credible threat of losses to creditors.
- Systemic liquidity charges:
  - BCBS new liquidity standards raise individual liquidity buffers and reduce maturity mismatches but are not designed to mitigate systemic liquidity risk (collective under-pricing of liquidity risk).
  - IMF (2011) suggests three potential measures for systemic liquidity risk measurement to inform macroprudential tools.
- Levies and taxes:
  - Levies or deposit insurance premiums could discourage excessive risk-taking and finance resolution costs.
  - Example country actions: bank levies in France, Germany, Hungary, Sweden, and the United Kingdom; risk-based deposit insurance premiums in the United States.
  - Levies should be linked to a credible resolution mechanism to avoid perceptions that paying institutions will not be allowed to fail; levies complement but do not substitute for higher capital.
- More intensive and proactive supervision:
  - Failures in governance, risk management, and information systems impeded risk identification and timely intervention.
  - Supervisory needs for SIFIs:
    - Mandate, resources, and operational independence.
    - Full powers and political backing for early intervention.
    - Supervisory approaches/techniques reflecting financial system complexity.
    - Higher supervisory standards for SIFIs; establishment of supervisory colleges and FSB peer review process.
  - Supervisory effectiveness requires political backing and resources; alignment of compensation incentives as per FSB recommendations is important.
- Enhanced transparency and disclosure:
  - Market discipline requires routine, timely, and accurate disclosure of exposures, off-balance-sheet items, complex products, interconnectedness, and cross-border exposures.
  - Key data gaps: sectoral, market, and cross-border exposures; off-balance-sheet items; extent of interconnectedness; financial stability indicators; OTC derivative market transparency.
  - Agreement reached on a data template for global SIFIs; should be extended to all SIFIs.
- Resolution frameworks and resolvability:
  - Essential to make orderly resolution feasible without systemic disruption, moral hazard, or taxpayer losses.
  - FSB recommendations (with Fund coordination) focus on:
    - Effective resolution regimes and tools (legal reforms, resolution authority with tailored powers).
    - Effective cross-border coordination mechanisms.
    - Mandatory recovery and resolution planning (RRPs, living wills) for G-SIFIs.
  - National progress: U.S. Dodd-Frank “Orderly Liquidation Authority”; new regimes in Belgium, Germany, Sweden, Switzerland, United Kingdom; EC proposals for RRPs and powers to transfer failing bank business to bridge banks.
  - Cross-border progress is limited: differences in national frameworks, absence of mutual recognition, lack of home-host burden-sharing arrangements, and legal/operational impediments hinder cross-border orderly resolution.
  - IMF interim proposal: amend national laws to remove legal impediments to international cooperation and allow only countries satisfying core coordination standards to participate; standards include harmonized resolution laws, rescinding discriminatory national legislation, effective resolution tools and creditor safeguards, strengthened regulatory cooperation, and enhanced authority capacity.
  - RRPs (living wills): recovery plan by firm and resolution plan by authorities; provide essential information on assets, liabilities, exposures, and legal/operational structure; implementation may face challenges due to complexity, reputational effects during distress, and the need for cross-border cooperation.
- Effective burden-sharing with the private sector:
  - Bail-inable debt or bail-in statutory powers can convert private debt into equity to provide loss-absorbing capacity during stress, increasing market discipline and reducing taxpayer exposure.
  - Bail-in tools give resolution authorities statutory means to write down debt or convert debt to equity as part of restructuring.

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*Source: IMF staff executive summary from the PDF chapter titled “_sdn1112 - EXECUTIVE SUMMARY.”*

### Box 1. Bail-inable Debt Proposals

### Box 1. Bail-inable Debt Proposals

### Concept and intended role
- Bail-in proposals are being considered as a market-based tool to address moral hazard risks associated with SIFIs.
- Objective: to incentivize institutions to raise capital or to restructure debt voluntarily before a triggering of the bail-in power.
- General features:
  - Provide a statutory approach to debt write-downs and debt-equity conversion.
  - Give authorities a power to add to the capital base of a failing institution via regulatory intervention while the institution is operating under official administration (conservatorship).
  - Preserve the traditional priority of claims present in a formal liquidation (equity absorbs first loss, followed by subordinated debt holders, followed by unsecured debt holders), with the prospect that, according to this priority, debt holders will obtain an equity interest.
  - The prospect of conversion rules on debt may add to market discipline and help curb excessive risk-taking.
- Jurisdictional interest: regulators in several countries (Canada, the United States, and others in Europe) have shown interest; concept, scope, and role are under discussion within the Basel Committee, FSB, and EU.
- Footnote: The Basel Committee issued minimum requirements on January 13, 2011, to ensure that all classes of capital instruments fully absorb losses at the point of nonviability before taxpayers are exposed to loss.

### Legal, cross-border, and scope considerations
- For bail-in to be effective, design must overcome legal challenges and cross-border implementation difficulties while mitigating potential systemic risks.
- Legal-framework issues:
  - Statutory bail-in must be carefully elaborated to reduce legal uncertainty because creditors would be forced to give up full legal claims upon the trigger event.
  - Potential conflicts with laws that guarantee property rights if bail-in is applied retroactively or without explicit terms and conditions built into the investment recognizing authorities’ rights for debt write-off or conversion at point of nonviability.
  - Effectiveness depends crucially on recognition within all relevant jurisdictions; international coordination is important to preserve a level playing field and avoid unintended consequences for bank debt markets.
- Scope guidance:
  - In principle, deposits, secured claims, and qualified financial contracts should be excluded from the scope of debt subject to bail-in.

### Design and financial-stability risks
- Bail-in instruments should not be a stand-alone tool; they should be accompanied by:
  - Strengthened supervision.
  - An enhanced capital base.
  - Improved disclosure.
  - An effective resolution regime.
- Risks and uncertainties:
  - Triggering bail-in power could send negative market signals and destabilize markets during times of high market volatility and uncertainty.
  - Marketability of instruments subject to bail-in is uncertain given potential discretionary elements and investors’ lack of familiarity.
  - Careful monitoring by supervisory authorities of implied transfer of risks within the financial system and potential build-up of systemic risks will be important.
  - There may be a case for restricting some holders of convertible instruments to limit contagion effects across SIFIs.
  - Ensuring consistency, transparency, and standardization is important to avoid complex structures and support cross-border crisis management.

### Conclusions and policy implications (measures to address TITF and reinforce effectiveness)
- Overarching principle: No private financial institution should be viewed by markets as being too important to be allowed to fail.
- Mutually reinforcing core policies to internalize risks and limit negative externalities:
  - Materially more stringent capital requirements (and possibly liquidity requirements as appropriate methodologies are developed), designed to reduce the probability of failure and to limit systemic risk contributions.
  - Intensive and proactive supervision commensurate with their complexity and risks.
  - Enhanced transparency and disclosure requirements for early identification of risks.
  - Effective resolution regimes at the national and global level to make resolution a credible, feasible, and viable option in the event of nonviability.
- Four supporting elements to reinforce effectiveness and limit unintended consequences:
  - Better policing of firewalls and links between regulated and unregulated sectors and enhanced disclosure requirements for the nonbank sector to limit indirect risk retention and relocation of systemic risk.
  - Improved understanding of the shadow banking system to prevent unregulated nonbank institutions from gaining systemic importance.
  - Effective cross-border arrangements for cooperation, information-sharing, and funding to facilitate cross-border resolution and limit regulatory arbitrage in the absence of harmonized SIFI measures.
  - Management incentives realigned (for example, through effective compensation policies linked to better and sound performance) to limit incentives for excessive risk-taking.
- Outstanding and complex issues requiring tangible progress:
  - Finalizing the methodology (and scope of application) to identify SIFIs.
  - Determining the level, composition, and coverage of a capital surcharge.
  - Institutionalizing international standards and translating recommendations for intensive supervision of SIFIs into national practices.
  - Addressing data gaps.
  - Agreeing on cross-border resolution arrangements.
  - Making visible progress in reforming compensation policies to align compensation structures with prudent risk-taking, along the lines recommended by the FSB.
- Transitional and interim measures:
  - A subset of simple and straightforward measures could be implemented internationally on a consistent basis in the interim.
  - These would include an announcement that SIFIs identified as TITF will be required to hold significantly more high-quality (loss-absorbing) capital than systemically less important institutions.
  - Actions to accelerate adoption of the FSB recommendations for enhanced supervision to reduce the risk that tighter requirements simply relocate systemic risk to affiliates subject to less or no regulation.
  - While Basel capital requirements are minimum standards, SIFIs identified as TITF should have higher equity capital requirements than required by Basel III of all banks as more progress is made on other components of the TITF solution (such as effective national and cross-border resolution regimes).
  - There should be a reasonable transition period during which undercapitalized banks can build their capital bases to limit risks to the real sector from any reduced availability of credit.
  - Higher capital requirements combined with enhanced supervision would have the teeth required to reduce SIFIs’ propensity to accumulate systemic risk.
  - These actions should be applied across all major jurisdictions as the transition to full implementation of the TITF framework is achieved.

*Source: Box 1. Bail-inable Debt Proposals.*

### REFERENCES

### REFERENCES

### Major reviews, books, and speeches on "Too Big to Fail" and financial-system fragility
- Alessandri, P., and A.G. Haldane, 2009, “Banking on the State” (London: Bank of England). http://www.bankofengland.co.uk/publications/speeches/2009/speech409.pdf.
- Cho, D., 2009, “Banks ‘Too Big to Fail’ Have Grown Even Bigger,” Washington Post (August 28).
- Cline, W., 2010, Financial Globalization, Economic Growth, and the Crisis of 2007-09, Peterson Institute of International Economics (Washington).
- Goodhart, C., 2010, “How Should We Regulate Bank Capital and Financial Products? What Role for ‘Living Wills’?” in The Future of Finance and the Theory that Underpins It: The LSE Report, ed. By A. Turner, A. Haldane, P. Woolley, S. Wadhwani, C. Goodhart, A. Smithers, A. Large, J. Kay, M. Wolf, P. Boone, S. Johnson, and R. Layard (London: London School of Economics and Political Science).
- Haldane, A., 2010, “The $100 Billion Question,” Speech to Institute of Regulation and Risk, Hong Kong (March 30). http://www.bankofengland.co.uk/publications/news/2010/036.htm.
- Johnson, S., and J. Kwak, 2010, 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown (New York: Random House).
- Tarullo, D., 2009, “Confronting Too Big to Fail,” Speech at the Exchequer Club, Washington, D.C. (Washington: Board of Governors of the Federal Reserve System, October 21). http://www.federalreserve.gov/newsevents/speech/tarullo20091021a.htm.

### Regulatory frameworks, standards, and policy reports (BCBS, BIS, FSB, FSF, EU)
- Basel Committee on Bank Supervision (BCBS), 2009a, “Adjustments to the Basel II Market Risk Framework,” press release (Basel: Bank for International Settlements, June 18). http://www.bis.org/press/p100618.htm.
- Basel Committee on Bank Supervision (BCBS), 2009b, Revisions to the Basel II Market Risk Framework, Final Version (Basel: Bank for International Settlements, July). http://www.bis.org/publ/bcbs158.htm.
- Basel Committee on Bank Supervision (BCBS), 2009c, Strengthening the Resilience of the Banking Sector (Basel: Bank for International Settlements, December). http://www.bis.org/publ/bcbs164.htm.
- Basel Committee on Bank Supervision (BCBS), 2010, “The Group of Governors and Heads of Supervision Reach Broad Agreement on Basel Committee Capital and Liquidity Reform Package,” press release (Basel: Bank for International Settlements, July 26, 2010). http://www.bis.org/press/p100726.htm.
- Bank for International Settlements (BIS), 2010, 80th Annual Report. (Basel, June).
- Financial Stability Board (FSB), 2010a, “Financial Stability Board Meets in Seoul,” press release (Basel: Bank for International Settlements, October 20). http://www.financialstabilityboard.org/press/pr_101020.pdf.
- Financial Stability Board (FSB), 2010b, FSB Report on Progress Since the Washington Summit (Basel: Bank for International Settlements, November). http://www.financialstabilityboard.org/publications/r_101111b.htm.
- Financial Stability Board (FSB), 2010c, “G20 Leaders Endorse FSB Policy Framework for Addressing Systemically Important Financial Institutions,” press release (Basel: Bank for International Settlements, November 12). http://www.financialstabilityboard.org/press/pr_101111a.pdf.
- Financial Stability Board (FSB), 2010d, Intensity and Effectiveness of SIFI Supervision: Recommendations for Enhanced Supervision, prepared in consultation with the IMF (Basel: Bank for International Settlements, November 1). http://www.financialstabilityboard.org/publications/r_101101.pdf.
- Financial Stability Board (FSB), 2010e, “Letter to G20 Leaders on Progress of Financial Regulatory Reforms,” press release (Basel: Bank for International Settlements, November 9). http://www.financialstabilityboard.org/publications/r_101109.pdf.
- Financial Stability Board (FSB), 2010f, Reducing the Moral Hazard Posed by Systemically Important Financial Institutions (Basel: Bank for International Settlements, November 11). http://www.financialstabilityboard.org/publications/r_101111a.pdf.
- Financial Stability Forum (FSF), 2009, FSF Principles for Sound Compensation Practices (Basel: Bank for International Settlements, April 2). http://www.financialstabilityboard.org/publications/r_0904b.pdf.
- European Commission (EC), 2010, An EU Framework for Crisis Management in the Financial Sector, COM(2010) 579 final (Brussels, October 20). http://ec.europa.eu/internal_market/bank/docs/crisis-management/framework/com2010_579_en.pdf.
- European Commission (EC), 2011, “Technical Details of a possible EU Framework for Bank Recovery and Resolution,” DG Internal Market and Services Working Document (Brussels, January). http://ec.europa.eu/internal_market/consultations/docs/2011/crisis_management/consultation_paper_en.pdf.
- U.K. Financial Services Authority (FSA), 2009, The Turner Review: A Regulatory Response to the Global Banking Crisis. (London, March). www.fsa.gov.uk/pubs/other/turner_review.pdf.

### IMF, IMF collaborative reports, and IMF staff notes on systemic risk, SIFIs, and resolution
- International Monetary Fund (IMF), 2010a, “A Fair and Substantial Contribution by the Financial Sector, Report to the G-20” (Washington, June). http://www.imf.org/external/np/g20/pdf/062710b.pdf.
- International Monetary Fund (IMF), 2010b, Global Financial Stability Report, April (Washington). http://www.imf.org/external/pubs/ft/gfsr/2010/01/index.htm.
- International Monetary Fund (IMF), 2010c, “Systemic Liquidity Risk: The Resilience of Institutions and Markets,” Chapter 2 in Global Financial Stability Report, October. (Washington). http://www.imf.org/external/pubs/ft/gfsr/2010/02/pdf/chap2.pdf.
- International Monetary Fund (IMF), 2010d, “Resolution of Cross-Border Banks—A Proposed Framework for Enhanced Coordination” (Washington). http://www.imf.org/external/np/pp/eng/2010/061110.pdf.
- International Monetary Fund (IMF), 2011, Global Financial Stability Report, April (Washington). http://www.imf.org/external/pubs/ft/gfsr/2011/01/index.htm.
- IMF/BIS/FSB, 2009, “Guidance to Assess the Systemic Importance of Financial Institutions, Markets, and Instruments: Initial Consideration, Report with the Bank for International Settlements to the G-20,” Report to the G-20 Finance Ministers and Central Bank Governors by the Staff of the International Monetary Fund and the Bank for International Settlements, and the Secretariat of the Financial Stability Board (Washington and Basel: International Monetary Fund, Bank for International Settlements, and Financial Stability Board, October). http://www.imf.org/external/np/g20/pdf/100109.pdf.
- IMF/BIS/FSB, 2010, “Capital and Liquidity Surcharges and Financial Levies and Taxes: Coherence and Consistency: A Note by the FSB, IMF, and BCBS” (Washington and Basel: International Monetary Fund, Bank for International Settlements, and Financial Stability Board, April 18).
- Viñals, J., 2009, “Too Important to Fail?” iMFdirect (December 8). http://blog-imfdirect.imf.org/2009/12/08/too-important-to-fail/.
- Viñals, J., J. Fiechter, C. Pazarbasioglu, L. Kodres, A. Narain, and M. Moretti, 2010, “Shaping the New Financial System,” IMF Staff Position Note 10/15 (Washington: International Monetary Fund). http://www.imf.org/external/pubs/cat/longres.aspx?sk=24204.0.
- Viñals, J., J. Fiechter, and others, 2010, “The Making of Good Supervision: Learning to Say No,” IMF Staff Position Note 10/08 (Washington: International Monetary Fund). www.imf.org/external/pubs/ft/spn/2010/spn1008.pdf.
- Johnston, R. B., E. Psalida, P. de Imus, J. Gobat, M. Goswami, C. Mulder, and F. Vazquez, 2009, “Addressing Information Gaps,” IMF Staff Position Note 09/06 (Washington: International Monetary Fund, March).
- Ötker-Robe, İ., C. Pazarbasioglu, and others, 2010, “Impact of Regulatory Reforms on Large Complex Financial Institutions,” IMF Staff Position Note 10/16 (Washington: International Monetary Fund). http://www.imf.org/external/pubs/cat/longres.aspx?sk=24314.0.
- Pazarbasioglu, C., J. Zhou, V. Le Leslé, and M. Moore, 2011, “Contingent Capital: Economic Rational and Design Features,” IMF Staff Discussion Note 11/01 (Washington: International Monetary Fund, January). imf.org/external/pubs/ft/sdn/2011/sdn1101.pdf.
- Fiechter, J., İ. Ötker-Robe, A. Ilyina, M. Hsu, A. Santos, and J. Surti, 2011, “Subsidiaries or Branches: Does One Size Fit All?” IMF Staff Discussion Note 11/4 (Washington: International Monetary Fund). www.imf.org/external/pubs/ft/sdn/2011/sdn1104.pdf.
- Chow, J., and J. Surti, 2011, “Restricting the Size and Scope of Activities of Systemically Important Financial Institutions,” IMF Working Paper (forthcoming; Washington: International Monetary Fund).
- Buffa di Perrero A., A. Ilyina, S. Iorgova, T. Kisinbay, and V. Tulin, 2011, “The Too-Important-To-Fail Problem: Some Stylized Facts,” IMF Working Paper (forthcoming; Washington: International Monetary Fund).

### Academic and empirical studies on consolidation, diversification, and conglomerates
- Amel D., C. Barnes, F. Panetta, and C. Salleo, 2004, “Consolidation and Efficiency in the Financial Sector: A Review of the International Evidence,” Journal of Banking & Finance, Vol. 28, pp. 2493–519.
- DeYoung, R., D. Evanoff, and P. Molyneux, 2009, “Mergers and Acquisitions of Financial Institutions: A Review of the Post–2000 Literature,” Journal of Financial Services Research, Vol. 36, pp. 87–110.
- Laeven, L., and R. Levine, 2007, “Is There a Diversification Discount in Financial Conglomerates?” Journal of Financial Economics, Vol. 85, pp. 331–67.
- Schmid, M. M., and I. Walter, 2009, “Do Financial Conglomerates Create or Destroy Economic Value?” Journal of Financial Intermediation, Vol. 18, pp. 193–216.
- Stiroh, K.J., and A. Rumble, 2006, “The Dark Side of Diversification: The Case of U.S. Financial Holding Companies,” Journal of Banking and Finance, Vol. 30, pp. 2131–161.
- van Lelyveld, I., and K. Knot, 2009, “Do Financial Conglomerates Create or Destroy Value? Evidence for the EU,” Journal of Banking and Finance, Vol. 33, pp. 2312–321.
- Miles, D., J. Yang, and G. Marcheggiano, 2011, “Optimal Bank Capital,” Discussion Paper 31 (London: Bank of England, External MPC Unit, January).

### Risk management, derivatives concentration, and supervisory lessons
- Senior Supervisors Group, 2008, “Observations on Risk Management Practices during the Recent Market Turbulence” (New York: Federal Reserve Bank of New York, March).
- Senior Supervisors Group, 2010, “Risk Management Lessons from the Global Banking Crisis of 2008” (New York: Federal Reserve Bank of New York, October).
- Mengle, D., 2010, “Concentration of OTC Derivatives among Major Dealers,” ISDA Research Notes, Issue 4. www2.isda.org/attachment/MTY3OA==/ConcentrationRN_4-10.pdf.
- Herring, R., 2009, “Wind-Down Plans as an Alternative to Bailouts,” Briefing Paper 15 (Washington: Pew Financial Reform Project). http://www.pewfr.org/admin/project_reports/files/Wind-down-plans.pdf.
- Wheelock, D. and P. Wilson, 2009, “Are U.S. Banks Too Large?,” Federal Reserve Bank of St. Louis Working Paper 2009-054B, (St. Louis: December).
- Shecter, B., 2011, “Post-Crisis, Bank Risk on Rise Again Financial Post,” Calgary Herald (March 29), http://www.calgaryherald.com/story_print.html?id=4517378&sponsor=curriebarracks.

*References list as provided in the source document.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/sdn/2011/_sdn1112.pdf_