How Do We Kill ‘Too Big to Fail’?

Too Big To FailThe term “systemically important financial institution” — or SIFI — fell into common use in the wake of the 2008 financial crisis. According to the Financial Stability Board, “SIFIs are financial institutions whose distress or disorderly failure, because of their size, complexity and systemic interconnectedness, would cause significant disruption to the wider financial system and economic activity.”

In other words: SIFIs are too big to fail, a term which itself has become so commonly used, its acronym (TBTF) has replaced it in vernacular. In 2011, the FSB published a list of global SIFIs (or G-SIFIs) alongside a series of proposed policy measures to address them in the event of a collapse. Some of the institutions included on the list are: Bank of America (NYSE:BAC), Barclays (NYSE:BCS), Citigroup (NYSE:C), HSBC (NYSE:HBC), and JPMorgan (NYSE:JPM).

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Financial industry participants and regulators have debated the issue of TBTF for years, and have made only modest progress toward a fully fleshed-out solution. In 2011, G20 leaders asked the FSB to “develop a policy framework to address the systemic and moral hazard risks associated with [SIFIs].” One of the key requirements the group outlined was an additional loss-absorption capacity at SIFIs scaled to the estimated impact of their collapse. This capacity ranges between 1 percent and 2.5 percent of risk-weighted assets, and is to be met with common equity.

Speaking at a conference sponsored by the International Monetary Fund in Washington, D.C., on Wednesday, Jeremy Stein, a member of the Board of Governors of the Federal Reserve, explored the logic behind this requirement, and why it may be the best method to address TBTF currently on the table.