What Is Too Big to Fail?
"Too big to fail" describes a concept in which the government will intervene in situations where a business has become so deeply ingrained in the functionality of an economy that its failure would be disastrous to the economy at large. If such a company fails, it would likely have a catastrophic ripple effect throughout the economy.
The failure may cause problems with companies which rely on the failing company's business as a customer as well as problems with unemployment as workers lose their jobs. Conceptually, in these situations, the government will consider the costs of a bailout in comparison to the costs of allowing economic failure in a decision to allocate funds for help.
Too Big To Fail
Too Big to Fail Financial Institutions
The “too big to fail” colloquialism centers around the idea that certain businesses, such as the biggest banks, are so vital to an economy that it would be disastrous if they went bankrupt. To avoid a crisis, the government can provide bailout funds which support failing business operations, protecting companies from their creditors and also protecting creditors against losses.
Those financial institutions which fall into the "too big" category include banks, insurance, and other finance organization. They carry the identifier of being systemically important banks (SIBs) and systemically important financial institutions (SIFIs). These financial organizations received regulation under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.
- Too big to fail is a colloquialism applied to the theory that some businesses would cause widespread damage to the economy if they fail.
- Under this concept, the government will intervene in situations where failure threatens the economy at large.
- Too big to fail became a common phrase during the 2008 Financial Crisis.
- The 2008 Financial Crisis led to widespread financial sector reform in the U.S. and globally.
- Key regulations post-crisis include the Emergency Economic Stabilization Act of 2008.
- The Emergency Economic Stabilization Act included the $700 billion Troubled Asset Relief Program (TARP), the Dodd-Frank Act of 2010 and new global Basel standards.
Background on Bank Reform
Following the bank failures of the Great Depression, deposit insurance and regulators, such as the Federal Deposit Insurance Corporation (FDIC), were created to step in and efficiently insure customers while also participating in the bank liquidation process if necessary. As such, FDIC-insured deposits helped Americans to be confident in their deposits of money into the banking system. FDIC reforms also promoted saving for the future covering individual accounts in member banks up to US$250,000 each.
While this government regulation has been effective for U.S. depositors, a lack of extended fail-safes into the broader corporate world became evident in a new financial crisis surfacing near the beginning of the 21st century. In 2007 and 2008, deeply indebted banks without FDIC protection faced failure. These institutions were responsible for collectively loose and, in some cases, even fraudulent lending practices across the financial industry which caused widespread defaults.
Lehman Brothers’ collapse marked the peak of the financial crisis in September 2008. With its bankruptcy filing, government regulators discovered the biggest banking firms were so interconnected that only large bailouts would prevent a substantial portion of the financial sector from failing.
As a result, the government enacted the Emergency Economic Stabilization Act (EESA) of 2008 which was signed in October 2008. Central to the Act was a $700 billion Troubled Asset Relief Program (TARP) to be managed by the U.S. Treasury for the purpose of helping distressed banks.
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 followed the Emergency Economic Stabilization Act and was created to instill new regulations that would help to avoid future bailouts. This included new requirements for capital holdings and increased capital reporting for regulatory review. Banks are now required to have specific capital levels and to create living wills outlining how they would liquidate assets quickly if filing for bankruptcy.
Dodd-Frank also imposed higher requirements for banks collectively labeled systemically important financial institutions (SIFIs).
Global Banking Reform
The 2008 financial crisis was a global crisis that affected banks around the world. Worldwide regulators also instilled new reforms with the majority of new regulations focused on too big to fail banks. Global banking regulation is primarily led by the Financial Standards Board in conjunction with the Bank for International Settlements and the Basel Committee on Banking Supervision. Examples of some international companies considered global systemically important financial institutions include:
- Bank of China
- BNP Paribas
- Deutsche Bank
- Credit Suisse
Real World Example
These SIFIs are identified as America’s too big to fail banks by their total assets and have higher reporting standards to ensure their operational efficiency. As of 2019, these companies include:
- Bank of America Corporation
- The Bank of New York Mellon Corporation
- Barclays PLC
- Citigroup Inc.
- Credit Suisse Group AG
- Deutsche Bank AG
- The Goldman Sachs Group, Inc.
- JP Morgan Chase & Co.
- Morgan Stanley
- State Street Corporation
- UBS AG
- Wells Fargo & Company