29 April 2015

BIS: Banks - allowing them to fail

Dr Andreas Dombret stated that preventing financial crisis from happening again is as complex and multi-layered as the crisis itself. Many observers wish there was a silver bullet that would solve the crisis with one clean shot, but there is no such silver bullet.

It is usually labelled the "too big to fail" problem. It refers to banks that are so big, so interconnected or so important that their failure might bring down the entire financial system. Consequently, the government has an incentive to step in and bail out these banks in order to prevent a systemic meltdown.

Banks that were deemed "too big to fail" therefore operated with implicit government support that was provided free of charge. Such support, however, can induce banks to engage in risky transactions. If things go well they take the profit, but if things go wrong the taxpayer foots the bill. Obviously, this is a less than optimal situation from any point of view but the banks'.

Mr. Dombret sums up: “Many people blame untamed market forces for the financial crisis of 2008. I argue that it was, in fact, not too much market but too little that contributed to the near-collapse of the financial system. A core characteristic of any well-functioning market economy was absent from the financial sector, namely the threat of failure. Large banks operated with implicit government support that distorted their incentives for prudent behaviour and eventually cost taxpayers billions of euros.

“Therefore, the regulatory reforms aim to reintroduce the principle of individual failure into the financial system. To reach this objective we have to establish mechanisms that allow banks to fail without disrupting the entire financial system. We have made significant progress both at the European and at the global level. And although we have not yet reached our objective, I am confident that we will eventually do so.

Full statement

© BIS - Bank for International Settlements