Too-big-to-fail Research Articles

Does the Too-Big-To-Fail status affect depositor’s discipline: a Gaussian mixture model algorithm approach

PurposeThis study empirically demonstrates a contradiction between pillar 3 of Basel norms III and the designation of Systemically Important Banks (SIBs), also known as Too Big to Fail (TBTF). The objective of this study is threefold, which has been approached in a phased manner. The first is to determine the systemic importance of the banks under study; second, to examine if market discipline exists at different levels of systemic importance of banks and lastly, to examine if the strength of market discipline varies at different levels of systemic importance.Design/methodology/approachThis study is based on all the public and private sector banks operating in the Indian banking sector. The Gaussian Mixture Model algorithm has been utilized to classify banks into distinct levels of systemic importance. Thereafter, market discipline has been observed by analyzing depositors' sentiments toward banks' risk (CAMEL indicators). The analysis has been performed by employing the system Generalized Method of Moments (GMM) to estimate models with different dependent variables.FindingsThe findings affirm the existence of market discipline across all levels of systemic importance. However, the strength of market discipline varies with the systemic importance of the banks, with weak market discipline being a negative externality of the SIBs designation.Originality/valueBy employing the Gaussian Mixture Model algorithm to develop a framework for categorizing banks on the basis of their systemic importance, this study is the first to go beyond the conventional method as outlined by the Reserve Bank of India (RBI).

Methods for alleviating the problem of Too big to fail in Germany

As a result of the last financial crisis, the problem of Too big to fail (TBTF) escalated in many countries, among which in Germany. The complexity and volume of the investment activity run by many banks caused liquidity problems which threaten their further operations. Therefore, in order to stabilize the financial market, the countries were forced to dedicate significant public resources to save the banks threatened with failure. Animated discussion on the TBTF banks made it necessary to seek regulatory solutions which would reduce the scale of TBTF problem. These solutions should be based on higher capital requirements, recovery and resolution of credit institutions, regulating derivatives and hedge funds as well as structural reforms of the banking sector in the spirit of the Glass–Steagall Act. The aim of this article is to present the structural reforms implemented in Germany under the so-called Trennbankengesetz and the assessment of their impact on reducing the scale of TBTF problem in Germany. The authors propose a research hypothesis stating that the structural reforms of banking sector implemented in Germany are too liberal to definitively solve the TBTF problem. That is why in the last part of this article, the authors have formulated their own proposals to reform the banking system in the spirit of Glass–Steagall Act, taking into consideration the universal model, typical of the German banking sector.

Discipline de marché par la dette subordonnée

Nous analysons l’impact de l’opacité des banques et de la crédibilité de l’absence d’intervention des autorités en cas de défaillance d’une banque sur l’efficacité de la discipline de marché. Nous montrons que pour les banques les plus opaques, pour celles perçues comme « too-big-to-fail » ou en période de forte incertitude, la mise en place d’une politique de dette subordonnée peut s’avérer contreproductive et conduire la banque à choisir un monitoring insuffisant. Pour favoriser la discipline de marché, les régulateurs devraient imposer plus de transparence et faire en sorte que des créanciers soient, de manière crédible, soumis à des pertes potentielles. L’utilisation de la dette subordonnée convertible pourrait ainsi être une solution. Classification JEL : G21, G28.

The Moroccans “TOO BIG TO FAIL”, Moral Hazard and Liquidity Risk

The Moroccans “TOO BIG TO FAIL”, Moral Hazard and Liquidity Risk

The Influence of Market Concentration on Bank Performance and the Test of TBTF Behavior in China

There are 16 listed commercial banks in total in China. Based on the annual specific data of those banks in China from 2008 to 2013, this research intends to find out how bank size and market concentration affect its market efficiency. This paper aims to test whether there exists a TBTF (Too Big to Fail) behavior in China. However, there is no clear evidence which shows that Chinese systemically important banks have a higher fragility than other banks. The results show that systemically important banks perform better than others on cost and profit efficiency and do not take too much risks under the same condition, even in a concentrated market where there are few dominant large banks and the majority of banks are in small size. However, regards to assets, if a banking market is highly unequaled, it does harm to smaller banks’ performance and increases the instability of the whole banking system. The study argues that regulators should make an adjustment on market concentration according to reducing the gap of bank size between large and small banks, other than limiting the size of systemically important banks.

NIHAO V: too big does not fail – reconciling the conflict between ΛCDM predictions and the circular velocities of nearby field galaxies

Abstract We compare the half-light circular velocities, V1/2, of dwarf galaxies in the Local Group to the predicted circular velocity curves of galaxies in the Numerical Investigations of Hundred Astrophysical Objects (NIHAO) suite of Λ cold dark matter (ΛCDM) simulations. We use a subset of 34 simulations in which the central galaxy has a stellar luminosity in the range 0.5 × 105 < LV/ L⊙ < 2 × 108. The NIHAO galaxy simulations reproduce the relation between stellar mass and halo mass from abundance matching, as well as the observed half-light size versus luminosity relation. The corresponding dissipationless simulations overpredict the V1/2, recovering the problem known as too big to fail (TBTF). By contrast, the NIHAO simulations have expanded dark matter haloes, and provide an excellent match to the distribution of V1/2 for galaxies with LV ≳ 2 × 106 L⊙. For lower luminosities, our simulations predict very little halo response, and tend to overpredict the observed circular velocities. In the context of ΛCDM, this could signal the increased stochasticity of star formation in haloes below Mhalo ∼ 1010 M⊙, or the role of environmental effects. Thus, haloes that are ‘TBTF’, do not fail ΛCDM, but haloes that are ‘too small to pass’ (the galaxy formation threshold) provide a future test of ΛCDM.

“But Is It Literary?”: Generalist Racisms, Disciplinary Insularity, and the Limits of Too-Big-to-Fail Thinking

“But Is It Literary?”: Generalist Racisms, Disciplinary Insularity, and the Limits of Too-Big-to-Fail Thinking

A unified solution to the small scale problems of the ΛCDM model II: introducing parent-satellite interaction

We continue the study of the impact of baryon physics on the small scale problems of the ΛCDM model, based on a semi-analytical model (Del Popolo, 2009). With such model, we show how the cusp/core, missing satellite (MSP), Too Big to Fail (TBTF) problems and the angular momentum catastrophe can be reconciled with observations, adding parent-satellite interaction. Such interaction between dark matter (DM) and baryons through dynamical friction (DF) can sufficiently flatten the inner cusp of the density profiles to solve the cusp/core problem. Combining, in our model, a Zolotov et al. (2012)-like correction, similarly to Brooks et al. (2013), and effects of UV heating and tidal stripping, the number of massive, luminous satellites, as seen in the Via Lactea 2 (VL2) subhaloes, is in agreement with the numbers observed in the MW, thus resolving the MSP and TBTF problems. The model also produces a distribution of the angular spin parameter and angular momentum in agreement with observations of the dwarfs studied by van den Bosch, Burkert, & Swaters (2001).

BANKING AND PUBLIC POLICY: TOO BIG TO FAIL

“Too big to fail” (TBTF) is a major policy issue in banking. Large bank failures may impose losses on depositors and creditors that may impose large collateral damage on other financial institutions and beyond. Regulators are frequently incentivized either to delay recognizing a bank's insolvency or fail the bank but protect its creditors against loss. This paper argues that, while there is wide agreement that the cost of protecting creditors in the resolution of large financial institutions is excessively high, it is difficult to prevent this practice for a number of reasons. Until these disagreements are settled, TBTF will survive. (JEL G01, G18, G28)

A unified solution to the small scale problems of the ΛCDM model

We study, by means of the model proposed in Del Popolo (2009), the effect of baryon physics on the small scale problems of the CDM model. We show that, using this model, the cusp/core problem, the missing satellite problem (MSP), the Too Big to Fail (TBTF) problem, and the angular momentum catastrophe can be reconciled with observations. Concerning the cusp/core problem, the interaction among dark matter (DM) and baryonic clumps of 1% the mass of the halo, through dynamical friction (DF), is able to flatten the inner cusp of the density profiles. We moreover assume that haloes form primarily through quiescent accretion, in agreement with the spherical collapse model (SCM)-secondary infall model (SIM) prescriptions. The results of this paper follow from the two assumptions above.Concerning the MSP and TBTF problem, applying to the Via Lactea II (VL2) subhaloes a series of corrections similar to those of Brooks et al. (2013), namely applying a Zolotov et al. (2012)-like correction obtained with our model, and further correcting for the UV heating and tidal stripping, we obtain that the number of massive, luminous satellites is in agreement with the number observed in the MW. The model also produces an angular momentum distribution in agreement with observations, that is with the distribution of the angular spin parameter and angular momentum of the dwarfs studied by van den Bosch, Burkert, & Swaters (2001). In conclusion, the small scale problems of the CDM model can all be solved by introducing baryon physics.

Too big to fail in banking: What does it mean?

Interest in too big to fail (TBTF) resolutions of insolvent large complex financial firms has intensified in recent years. TBTF resolutions protect some in-the-money counterparties of a targeted insolvent firm from losses that they would suffer if the usual bankruptcy resolution regimes used in resolving other firms in the industry were applied. Although special TBTF resolution regimes may reduce the collateral spill-over costs of the failure, the combined direct and indirect costs from such “bailouts” may be large and often financed in part or in total by taxpayers. Thus, TBTF has become a major public policy issue that has not been resolved in part because of disagreements about definitions and thereby the estimates of the benefits and costs. This paper explores these differences and develops a framework for standardizing the definitions and evaluating the desirability of TBTF resolutions more accurately.

Enhancing Prudential Standards in Financial Regulations

The financial crisis has generated fundamental reforms in the financial regulatory system in the U.S. and internationally. Much of this reform was in direct response to the weaknesses revealed in the precrisis system. The new “macroprudential” approach to financial regulations focuses on risks arising in financial markets broadly, as well as the potential impact on the financial system that may arise from financial distress at systemically important financial institutions. Systemic risk is the key factor in financial stability, but our current understanding of systemic risk is rather limited. While the goal of using regulation to maintain financial stability is clear, it is not obvious how to design an effective regulatory framework that achieves the financial stability objective while also promoting financial innovations. This paper discusses academic research and expert opinions on this vital subject of financial stability and regulatory reforms. Specifically, among other issues, it discusses the impact of increasing public disclosure of supervisory information, the effectiveness of bank stress testing as a tool to enhance financial stability, whether the financial crisis was caused by too big to fail (TBTF), and whether the Dodd-Frank Wall Street Reform and Consumer Protection Act (DFA) resolution regime would be effective in achieving financial stability and ending TBTF.

Brown-Vitter Bill: A Proposal to Scrap Basel III in US

Senators Sherrod Brown and David Vitter have been working on a bill, Brown-Vitter Bill, which was introduced on April 24, 2013 to block the largest banks and financial firms from receiving federal subsidies for being deemed Big to Fail. This draft legislation clearly aims to end Too Big to Fail (TBTF). The idea that some financial institutions must be supported by the government rather than be allowed to fail (as per TBTF) is toxic to markets and costly to taxpayers.The bill's primary focus is to redefine and increase minimum regulatory capital ratio requirements -- in the form of common equity to total assets (including off-balance sheet assets) and to deemphasize the Basel Accord's risk-weighted approach to measuring capital, particularly for the largest U.S. banks.

Comment Letter to the U.S. Treasury Department Concerning the Regulatory Structure for Financial Institutions

This comment letter was submitted to the U.S. Treasury Department in connection with that Department's review of proposals for changes in the regulatory structure for financial institutions. The comment letter presents the following policy recommendations: (1) the thrift charter should be eliminated, existing thrifts should be required to convert into banks, and the Office of Thrift Supervision should be merged with the Office of the Comptroller of the Currency (OCC); (2) the dual banking system should be preserved and strengthened in order to promote innovation in banking regulation and to support the community bank sector; (3) at least one federal agency that is separate and independent from the OCC should be designated as the primary federal regulator for state-chartered banks; (4) the existing statutory limits on bank mergers and acquisitions should be maintained, including the 10% nationwide deposit cap and the 30% statewide deposit cap; (5) greater scrutiny and special conditions should be required for large bank mergers; (6) Congress should establish federal consumer protection standards for all home mortgage lenders, credit card lenders, and other providers of consumer credit; (7) Congress should prohibit the OCC from issuing regulations that preempt state law, except in specific areas where Congress has given the OCC explicit authority to adopt preemptive rules; (8) Congress should establish a separate and independent federal authority to enforce federal consumer protection laws against all providers of financial services, including national banks; (9) Congress should recognize the authority of state attorneys general to enforce applicable state laws against all financial service providers, including national banks, (10) Congress should provide the Federal Reserve Board (FRB) with direct oversight over all significant financial conglomerates that control FDIC-insured banks; (11) Congress should prohibit the FDIC's deposit insurance fund from making any payments to uninsured depositors or other uninsured claimants; and (12) all responsibility for protecting uninsured creditors of too big to fail (TBTF) financial institutions should be assigned to the FRB, and the FRB should impose assessments on significant financial conglomerates to recover the FRB's cost of providing financial assistance to TBTF institutions.

How Should We Respond to the Growing Risks of Financial Conglomerates?

The structure of the U.S. financial services industry has been transformed during the past two decades by the combined forces of new technologies, deregulation and financial innovation. Large banks, securities firms and life insurers have responded to these forces by pursuing a twofold consolidation strategy - acquiring direct competitors within their traditional industry sector and making cross-industry acquisitions in other sectors. The Gramm-Leach-Bliley Act of 1999 ratified the ongoing trend toward cross-industry consolidation and facilitated the creation of large financial conglomerates. Based on empirical studies and the experience of the past two decades, it is highly doubtful whether the predicted benefits of financial conglomeration (e.g., greater efficiency, profitability, safety and convenience) will actually be realized. In addition, financial conglomeration has intensified the problem of systemic risk in the financial markets and has increased the probability that the too big to fail (TBTF) doctrine will be applied to major financial holding companies. Current supervisory approaches (including the proposed new Basel capital accord) are inadequate to cure the problems of supervisory forbearance and moral hazard that have been created by the TBTF policy. I propose a new plan for bank regulation and deposit insurance that will (1) insulate the deposit insurance funds from the cost of TBTF bailouts, (2) require financial conglomerates to internalize the costs of such bailouts, and (3) encourage greater market discipline over such institutions.

Submission Under Consultation Process by the European Commission on the Structural Reform of the Banking Sector

This is a response to the European Commission proposed regulation to address Too Big To Fail (TBTF). TBTF is a function of interconnections and size, not just being a bank but also doing bank-like activities. Limiting the discussion to just banks will not result in an effective policy solution. Also the frame of analysis does not take into account systemic questions, Too Big To Fail not being the important question. Shadow banking and hedge funds can be outside the parameters for TBTF but they can be Too Systemic To Fail. This set of discussions does not take that into account. We discuss how interconnected banks have become over the last decade and the need for this set of regulations to be more wide ranging. This was part of the European Commission consultation.

Too Big to Fail as a Game of Chicken with the State: What Insolvency Law Theory Has to Say About TBTF and Vice Versa

Governments have bailed out banks that were considered too big to fail (TBTF). In an attempt to end these bail-outs, the European Commission has presented a proposal for a Directive for a European framework for the recovery and resolution of credit institutions and investment firms. This article analyses what insolvency law theory has to say about TBTF and vice versa. The dominant insolvency law theory, the creditors’ bargain theory (CBT), does not do well in explaining the problems presented by TBTF. The CBT frames insolvency law as a set of rules to overcome common pool problems, most notably to prevent a destructive race to the assets by individual creditors. The problems TBTF presents, however, do not primarily relate to a race to the assets. In order to understand the TBTF problem and key elements of the Directive's response (capital write-down and bail-in), the CBT needs to be supplemented with the property law theory of anticommons and its explanation of hold-out behaviour. Common pool problems and anticommons problems have different game-theoretical companions. Whereas common pool problems can be explained by the prisoners’ dilemma, anticommons can trigger a game of chicken. In the case of TBTF, shareholders and creditors can engage in this game of chicken with the state. The Directive sends out the message that states will no longer be drawn into playing this game.

The Future of Financial Engineering

Convergence of financial theory and practice heralded by the seminal and fundamental economic research by Arrow and Debreu in the early 1950’s has led in the hands of financial engineers to an extraordinary financial innovation in the 70’s and ever since. The theoretical ability to price future assets has led to an explosive growth of financial trading, liquidity and to the growth of finance and its citadels. Options and credit derivative markets, securitization of non or partially liquid assets have provided extraordinary opportunities to “unearth” frozen assets for trade and profit. The 2007-2009 financial crisis has evoked a greater awareness that traditional financial dogma is based on assumptions that have become increasingly difficult to justify. Globalization, the growth of Too Big To Fail (TBTF) firms, insiders trading, information and power asymmetries and the growth of regulation have, among other factors, conspired to render the assumption of complete markets to be unsustainable. Deviant behaviors in financial markets, non-transparency of transactions, complexity and dependence on a global scale have created a fragile and contagious global economy, where systemic risks are no longer an exception but a permanent threat. By the same token, the explosive growth of information and data fueled by the internet and social media as well as an IT has created far greater dependence of financial systems and institutions on Information Technology (IT) emphasizing information as assets they seek to use for both financial management and competitive advantage. Technology, engineering and financial trends and developments have combined to yield an extraordinary growth of complexity, regulation and globalization, providing new opportunities and risks and undermine the traditional model based approaches to finance.The purposes of this paper are to outline a number of factors, economic or otherwise that undermine the finance’s fundamental theories, their practice, regulation and their implications to the future of finance. In particular, we emphasize a strategic and multi-polar finance, beset by complexity, chaos and countervailing forces leading a multi-agent finance, computational and financial data-analytics driven rather than simple risk models of uncertainty.A number of pricing models based on a strategic finance and a micro-matching of economic and financial states are also summarized and their practical implications drawn. In addition, topics such as Big Data finance and multi-agent financial modeling are outlined to provide elements for future theoretical and practical developments. This paper is a work in progress and therefore its intent is to attract greater attention to some elements (however selective and partial) that would contribute to potential transformations of a financial engineering future.

Compensation par contrepartie centrale et assurance contre le risque systémique sur les marchés dérivés de gré à gré

Les chambres de compensation peuvent-elles gérer les risques présents sur le marché de gré à gré des produits dérivés ? Pour répondre à cette question, nous exposons deux angles d’approche sur les pratiques de gestion des risques des chambres de compensation : l’angle des contrats se concentre sur la question de la gestion des pertes en cas de défaut, alors que sous l’angle des contreparties, on considère la probabilité d’un défaut en premier lieu et donc les incitations à prendre des positions risquées. En appliquant cette dernière approche au marché des contrats dérivés, nous concluons que l’introduction d’une chambre de compensation sur ce marché incitera à une prise de risque plus importante et à l’échec collectif des participants à prendre en compte la concentration du risque systémique sur ce marché. Cette externalité sera magnifiée avec l’introduction d’une chambre de compensation qui concentrera le risque et donc deviendra trop importante pour faire faillite. Afin de corriger ce problème, nous proposons une assurance contre le risque systémique comme composante nécessaire d’une chambre de compensation pour les produits dérivés.Classification JEL : G18, G23.

Resolving Too-Big-to-Fail Banks in the United States

The belief that some banks are too big to fail (TBTF) became reality during the financial crisis of 2007-2009 when the biggest banks in the United States were bailed out. Since then, big banks have grown much bigger and have become increasingly complex. This development has led to far greater attention on the need to resolve the TBTF problem. This paper examines the way in which the Federal Deposit Insurance Corporation (FDIC) has resolved troubled banks both historically and in the current TBTF situation in which the United States now finds itself. The paper examines post-crisis regulatory reform by focusing on the new orderly liquidation authority the Dodd-Frank Act provides to the FDIC to serve as the receiver for big banks whose failure poses a significant risk to the country’s financial stability. We assess whether this process will indeed eliminate the TBTF problem.