Systemically important banks: too big to fail

Abstract

The failure of a large financial institution is potentially harmful to the economy, especially if it results in the failure of other institutions of the financial system, giving rise to a systemic crisis. For this reason, during the crisis of 2008/2009, the United States and some European countries bailed out several large financial institutions. However, the policy of bailing out systemically important financial institutions, usually called too-big-to-fail, can be harmful to the long-run financial market stability because it can put the public finances under heavy strain, it weakens the incentives for creditors to monitor the banks, leading to increased moral hazard, and it distorts competition by benefiting the systemically important banks with a lower cost of capital. The proposed research aims to contribute to the debate on the governance of the financial system by investigating a related issue, though still unexplored in the international literature: the distortion of the competitive structure of the financial system due to the depositors' preference for systemically important institutions during periods of financial turmoil. The sample includes banks from different countries, and will focus on the behavior of depositors during the recent crisis in Europe to identify the presence of the too-big-to-fail effect and assess its potential implications. (AU)