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April 16, 2014

‘Too big to fail’ is too big to ignore

“No solvent government will allow its entire banking industry to collapse. Leveraged institutions whose liabilities are more liquid than their assets are inescapably vulnerable to panics. In a panic, it will be hard to distinguish illiquidity from insolvency. These three points shape my views: the state stands behind banking even though it might not stand behind individual institutions.”

“One of the obstacles to making the bearing of losses by creditors credible is “too big to fail” – the challenge posed by banks that are individually systemic. A question about post-crisis regulation is whether this risk is gone. The answer is no. Mark Carney, governor of the Bank of England and chairman of the Financial Stability Board, himself agrees that “firms and markets are beginning to adjust to authorities’ determination to end too-big-to-fail. However, the problem is not yet solved.”

“Indeed it is not, as a chapter on banks in the latest Global Financial Stability Report from the International Monetary Fund shows. “Subsidies rose across the board during the crisis but have since declined in most countries,” it concludes. “Estimated subsidies remain more elevated in the euro area than in the US . . . All in all, however, the expected probability that systemically important banks [SIBs] will be bailed out remains high in all regions.” Moreover, in another crisis, the necessary subsidies might jump once again.”

“One reason the problem is unlikely to have diminished is that the banking sector has tended to become even more concentrated. Furthermore, the total assets of a number of big banks have continued to soar: institutions with assets of $2tn are commonplace. (See charts.) Such banks remain highly interconnected, though the extent of this might have diminished recently.”

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Read full Financial Times article here.

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