A Tale of Titans: The Too Important to Fail Conundrum
IMF Blog, May 27, 2011
Source details
- Canonical URL
- A Tale of Titans: The Too Important to Fail Conundrum
Other formats
Bibliographic details
- Authors: Aditya Narain, nci tker-Robe
- Published: May 27, 2011
Overview and context
- Authors: Aditya Narain, İnci Ötker-Robe
- Date: May 27, 2011
- Topic: Systemically important financial institutions (SIFIs) and the “too important to fail” problem arising from size, complexity, interconnectedness, and lack of substitutes.
Key findings and analysis
- Financial institutions viewed as too important to fail have become larger and more complex since the global crisis.
- One institution’s failure can threaten the global financial system and create devastating effects on economies, illustrated by the Lehman Brothers example.
- The behavior of financial institutions can be a risk to the whole financial system if they fail; governments faced with potential failures may choose to bail them out with taxpayers’ money to prevent cascading effects.
- Bailouts are expensive: for countries that used public funds, estimated costs of direct support in the recent crisis reached on average about 7 percent of GDP.
- Addressing size alone cannot solve the problem; size does not capture the full dimension of systemic importance.
- Growing complexity, connections to other institutions and financial markets, and lack of substitutes magnify the propensity to trigger panics — these traits make institutions “too important to fail” rather than merely “too big to fail.”
- Institutions that were more interconnected appear to have had a higher likelihood of distress during the recent crisis than other financial institutions.
- The size of an institution relative to its home country economy or its financial system played a key role in authorities’ decisions about whether to bail it out in the event of distress.
- The too-important-to-fail institutions have grown in importance: their share of assets doubled during 2000-09, reaching a quarter of the total global assets.
- Growth of their assets, ranging from $50 billion to $3 trillion, in some cases outpaced the growth of their national economies.
- Implicit or explicit government backing gave such institutions a funding advantage: e.g., the largest banks in the United States have been able to borrow funds at lower rates than smaller banks, and this advantage widened after the crisis to about 80 basis points.
Policy recommendations and preferred measures
- Favor market-based measures to reduce the likelihood and impact of a failure, including:
- stricter capital requirements,
- more intensive supervision in line with an institution’s contribution to systemic risk,
- increased disclosure of their structure, exposures, and activities,
- effective resolution regimes that allow creditors to share any losses.
- Support for policy measures targeted specifically at SIFIs, including those put forward by the Financial Stability Board.
- Specific measures to internalize SIFI risks:
- stricter capital requirements designed to limit contribution to systemic risk,
- more intensive supervision of financial institutions in line with their complexity and risks,
- enhanced disclosure requirements on SIFIs’ activities, exposures and structures,
- effective resolution regimes nationally and globally.
- Interim measures recommended while implementation proceeds:
- require systemically important financial institutions to hold more loss-absorbing capital above what is required under Basel III,
- accompany higher capital with intensive and proactive supervision of regulated entities,
- efforts to limit regulatory arbitrage within and across borders and sectors,
- take rapid, credible, and visible actions to signal unified commitment to address the problem.
Implementation horizon and regulatory context
- Global regulators have introduced a new set of tighter rules for all banks, known as Basel III.
- Countries have until 2018 to comply with the new rules.
- A series of policy measures targeted at SIFIs have been proposed; implementation may take several years while systemic institutions continue to grow in size and complexity.
Risks and rationale for urgency
- Implementation delays could allow systemic institutions to resume risky practices while rules are phased in.
- The next failure of a systemically important institution could again prompt a government-funded rescue at a time when government finances are fragile in many countries.
- Interim measures are urged to provide a rapid, credible, and visible signal that the world is united to deal with the problem.
Source: A Tale of Titans: The Too Important to Fail Conundrum, Aditya Narain and İnci Ötker-Robe, May 27, 2011.
Content in this bundle
- Staff Discussion Note