Op-ed at VoxEu.org
April 14, 2011
The existence of too-big-to-fail financial institutions represents a three-fold policy challenge.
It is no wonder then that the too-big-to-fail issue is at the forefront of the debate on financial regulatory reform—at least as seen from Washington DC, London, and Zurich. Federal Reserve Chairman Ben Bernanke testified in September 2010 that "if the crisis has a single lesson, it is that the too big to fail problem must be solved" (Bernanke 2010). US Treasury Secretary Tim Geithner underscored that "the final area of reform (…) is perhaps the most important, establishing new rules to constrain risk-taking by—and leverage in—the largest global financial institutions" (Geithner 2010). The Dodd-Frank Act of 2010 contains a host of provisions targeted at the regulation and supervision of systemically-important financial institutions, including enhanced risk-based capital, leverage, and liquidity standards and the requirement to prepare and maintain extensive rapid and orderly dissolution plans. In the United Kingdom, Bank of England Governor Mervyn King emphasized in a recent interview that "the concept of being too important to fail should have no place in a market economy" (King 2011). And later this month, the Vickers Commission is slated to give its recommendations on the banking industry, including its verdict on the merits of separating functions within the largest banks. Meanwhile, in the strongest approach to date to deal with the too-big-to-fail problem, a committee of experts appointed by the Swiss Federal Council (and including a representative from the Swiss National Bank) recommended that the total capital requirement for Switzerland's two largest banks (UBS and Credit Suisse) be set at 19 percent of their risk-weighted assets, and that at least 10 percent of those assets must be held in the form of common equity (Committee of Experts 2010). If adopted, these capital requirements would be substantially more rigorous than the minimums recently agreed under Basel III (Goldstein 2011).
It is all the more remarkable then that the too-big-to-fail problem is barely present in substantial financial policy debates and initiatives in most continental European countries and at the EU level, including the European Commission. These jurisdictions have tended to favor the application of uniform regulations to financial institutions irrespective of size and systemic importance and have been generally reported as arguing against specific policies targeted at systemically-important financial institutions in international bodies such as the Basel Committee on Banking Supervision and the Financial Stability Board.
In a working paper that specifically analyses the transatlantic and intra-European variations of the too-big-to-fail debate (or absence thereof); we identify four broad reasons for this contrast (Goldstein and Véron 2011):
The discussion on possible remedies to the too-big-to-fail problem is not a simple one, and no silver bullet is at hand. There are different dimensions to the problem, each of which is associated with different policy options: absolute bank size (which may be addressed with size caps or capital surcharges), market concentration (which calls for competition policy or limits to market share), conglomeration (Glass-Steagall-like separations, or the more recent Volcker rule), internationalization (requirements for local funding and/or capitalization), and complexity (central clearing of transactions, living wills). Depending on the context, definitions of systemically-important financial institutions generally rely on a mix of these criteria. But many gaps remain in our analytical understanding of the too-big-to-fail problem. Furthermore, much of the available research tends to be focused on the US case, whose features may not be easily extrapolated to non-US contexts (Demirgüç-Kunt and Huizinga 2011).
However, these analytical gaps should not be taken as an excuse to avoid an in-depth debate on the too-big-to-fail problem in Europe; on the contrary. Moreover, given the potential risks to systemic stability, there is a case for policy action even in the absence of analytical certainty. The very large too-big-to-fail problem faced by most European countries should motivate a broad policy discussion on how to reform banking structures in Europe to mitigate it. The sooner the better.
Bernanke, Ben (2010), Testimony to the US Financial Crisis Inquiry Commission, September.
Bank for International Settlements (2010), 80th Annual Report, June.
Chaka, Martin, and Jörg Decreasing (2007), "The Case for a European Banking Charter," IMF Working Paper WP/07/73.
Committee of Experts (2010), "Final Report of Committee of Experts for Limiting the Risks Posed by Large Companies", Swiss Financial Market Supervisory Authority and Swiss National Bank, October.
Demirgüç-Kunt, Asli, and Harry Huizinga (2011), "Do we need big banks?," VoxEU.org, 18 March.
European Commission (2011), "Technical Details of a Possible EU Framework for Bank Recovery and Resolution," [pdf] DG MARKT working document, January.
Fonteyn, Wim, Wouter Bossu, Luis Cortavarria-Checkley, Alessandro Giustiniani, Alessandro Gullo, Daniel Hardy, and Sean Kerr (2010), "Crisis Management and Resolution for a European Banking System," IMF Working Paper WP/10/70, March.
Geithner, Timothy (2010), "Rebuilding the American Financial System," speech at NYU Stern School of Business, August.
Goldstein, Morris (2011), "Integrating Reform of Financial Regulation with Reform of the International Monetary System," Peterson Institute for International Economics Working Paper 11-5, February.
Goldstein, Morris, and Nicolas Véron (2011), "Too Big To Fail: The Transatlantic Debate," Peterson Institute for International Economics Working Paper 11-2, January.
Johnson, Simon (2009), "The Quiet Coup," The Atlantic, May.
King, Mervyn (2011), Interview in The Telegraph, March.
Véron, Nicolas (2007), "Is Europe Ready For a Major Banking Crisis?," Bruegel Policy Brief 2007/03, August.
Wall, Larry, Maria Nieto, and David Mayes (2011), "Creating an EU-Level Supervisor for Cross-Border Banking Groups: Issues Raised by the U.S. Experience with Dual Banking," [pdf] Federal Reserve Bank of Atlanta Working Paper 2011-06, March.
Working Paper 11-2: Too Big to Fail: The Transatlantic Debate January 2011
Testimony: Economic Crisis: The Global Impact of a Greek Default June 25, 2015
Testimony: Banking Union in Nine Questions September 30, 2014
Book: Managing the Euro Area Debt Crisis June 2014
Book: Inside the Euro Crisis: An Eyewitness Account June 2014
Testimony: European Banking Union: Current Outlook and Short-Term Choices February 26, 2014
Policy Brief 13-17: A Realistic Bridge Towards European Banking Union June 2013
Op-ed: Five Myths about the Euro Crisis September 7, 2012
Article: Why the Euro Will Survive: Completing the Continent's Half-Built House August 22, 2012
Testimony: Challenges of Europe's Fourfold Union August 1, 2012
Policy Brief 12-18: The Coming Resolution of the European Crisis: An Update June 2012
Book: Resolving the European Debt Crisis March 2012
Policy Brief 12-20: Why a Breakup of the Euro Area Must Be Avoided: Lessons from Previous Breakups August 2012
Policy Brief 12-5: Interest Rate Shock and Sustainability of Italy's Sovereign Debt February 2012
Policy Brief 12-4: The European Crisis Deepens January 2012
Policy Brief 11-13: Europe on the Brink July 2011
Book: Transforming the European Economy September 2004