Too big to fail and financial stability

Financial market participants can become so large at a national and even international level that their disorderly failure could undermine financial stability and force a de facto government bail-out. Following the global financial crisis of 2007 and 2008, the “too big to fail” problem was therefore addressed both in Switzerland and abroad.

Financial market participants can become so large and complex from a business perspective as well as being interlinked with other market participants that a disorderly failure could pose a risk to financial stability and damage entire economies. The measures to mitigate the too big to fail problem (TBTF) are designed to minimise these risks, reduce the likelihood of financial crises and limit the cost of a future crisis.

The too big to fail problem

The purpose of these measures is to strengthen the institutions’ resilience and they include raising loss absorption capacity, establishing comprehensive national resolution regimes and improving resolvability. The Financial Stability Board (FSB) coordinates the measures internationally.

In the global financial crisis of 2007 and 2008, many governments were forced to bail out distressed banks. A disorderly failure of these banks would have led to huge dislocations in the financial system and damaged the economies. TBTF refers to financial institutions that governments effectively cannot allow to go bankrupt due to their size and interconnectedness with the economy and financial system. However, government bail-outs are very problematic, as they are paid for by taxpayers. Moreover, the assumption that the government will always rescue a certain size of bank in a crisis leads to unintended distortions of competition and potential moral hazard.