Too big to fail

"Too big to fail" (TBTF) is a theory in banking and finance that asserts that certain corporations, particularly financial institutions, are so large and so interconnected with an economy that their failure would be disastrous to the greater economic system, and therefore should be supported by government when they face potential failure. The colloquial term "too big to fail" was popularized by U.S. congressman Stewart McKinney in a 1984 Congressional hearing, discussing the Federal Deposit Insurance Corporation's intervention with Continental Illinois. The term had previously been used occasionally in the press, and similar thinking had motivated earlier bank bailouts.

The term emerged as prominent in public discourse following the 2008 financial crisis. Critics see the policy as counterproductive and argue that large banks or other institutions should be left to fail if their risk management is ineffective. Some critics, such as economist Alan Greenspan, believe that such large organizations should be deliberately broken up: "If they're too big to fail, they're too big." Some economists, such as Paul Krugman, hold that financial crises arise principally from banks being under-regulated rather than their size, using the widespread collapse of small banks in the Great Depression to illustrate this argument.

In 2014, the International Monetary Fund and others said the problem still had not been dealt with. While the individual components of the new regulation for systemically important banks (additional capital requirements, enhanced supervision and resolution regimes) likely reduced the prevalence of TBTF, the fact that there is a definite list of systemically important banks considered TBTF has a partly offsetting impact.

Definition

Federal Reserve Chair Ben Bernanke also defined the term in 2010: "A too-big-to-fail firm is one whose size, complexity, interconnectedness, and critical functions are such that, should the firm go unexpectedly into liquidation, the rest of the financial system and the economy would face severe adverse consequences." He continued that: "Governments provide support to too-big-to-fail firms in a crisis not out of favoritism or particular concern for the management, owners, or creditors of the firm, but because they recognize that the consequences for the broader economy of allowing a disorderly failure greatly outweigh the costs of avoiding the failure in some way. Common means of avoiding failure include facilitating a merger, providing credit, or injecting government capital, all of which protect at least some creditors who otherwise would have suffered losses.