Too-Big-To-Fail: Regulatory Reforms of Systemically Important Institutions

Although the G20 finance ministers pledged stronger prudential regulation and financial oversight of systemically important firms at their September meeting, there is no consensus yet among regulators, lawmakers and academics on how best to proceed. Nouriel Roubini noted recently that the problem of banks being too big to fail is even bigger now than it was before the crisis: “Why don't we go to a system where they're not too big to fail to begin with? The true solution to the too-big-to-fail problem requires more radical choices. In addition to an insolvency regime, such institutions should be broken up and unsecured creditors of insolvent institutions should have their claim automatically converted into equity. A separation of commercial banking and risky investment banking should also be considered. Thus, some variant of the Glass-Steagall Act should be reintroduced.”

If the government creates a new firewall between deposit-taking institutions and investment banks, as was the case before the repeal of the 1935 Glass-Steagall Act in 1999, only the former group would receive access to lender of last resort facilities and deposit insurance. The latter should be subject to receivership should they get in trouble. Advocates of this solution include Paul Volcker (who chaired the Group of 30 report), Mervyn King (Governor of the Bank of England), and even Alan Greenspan favors a breakup, according to recent statements (although he supported the repeal of Glass-Steagall). Among policymakers, King has made a particularly forceful case, noting that "it is important that banks in receipt of public support are not encouraged to try to earn their way out of that support by resuming the very activities that got them into trouble in the first place.”