Critically discuss the concept of too big to fail, you may consider how it impacts regulation

or how a systemically important bank may behave differently as a result.

The Term Too Big to Fail is a label given to certain banks or financial institutions which have
been deemed too crucial to the national/ global economy, whereby their collapse would have
significant detrimental effects on said economy. In cases such as these the Government will
often issue financial bailouts to ensure these banks survive. The most notable of these
bailouts to take place in the UK was the Government’s £45.8 Billion [1] intervention to save
RBS in 2008 where the government bought 83% of the bank. This was done as a part of a
rescue package to several banks which at its peak cost £137 Billion in loans and new capital
and as of October 2021 still cost £33 Billion.

The term too big to fail originated from its use by US Congressman Stewart McKinney in a
1984 hearing about the bailout of the Continental Illinois National Bank. However, the term
became widely known in the aftermath of the 07-08 global financial crisis. Though there isn’t
a set criterion for a bank to be considered Too Big to Fail, the Financial Stability Board
publishes an annual list of banks it deems to be ‘Global Systemically Important Banks’ or ‘G-
SIBs’. In the UK these banks include Barclays, HSBC, Standard Chartered and until recently
included Lloyds, NatWest and RBS. The criteria applied to these banks by the FSB is that
they are large enough in capital, have a significant level of cross jurisdiction activity, are
complex, and are not easily substituted for another bank. These banks however, by virtue of
their placement on this list are held to a sort of higher standard. This is because through not
only international rules outlined in the Basel III [2] agreement but also UK regulations [3],
these banks are required to hold several times the loss absorbing capital than that of smaller
less structurally important banks. This is in an attempt to avoid what many saw to be ‘blank
checks’ that were given to banks following the 07-08 global financial crisis [4], and in turn to
prevent cost to the taxpayer if and when these banks fail again.

[1] Worrall P, ‘Factcheck: Will We Make a Profit from the Bank Bailouts [2] (Explainer-what is the ‘Basel III
endgame’ and why are banks worked up ...)

[3] Pollock I, ‘Taxpayer Bailouts for Banks “too Big to Fail” to End by 2022’ [4] ‘How Much Have UK Banks
Been Bailed Out?’

Since the aforementioned ‘Blank Check Writing’ which took place during the aftermath of
the 07-80 Global Financial Crisis, there has been a global change in attitude towards these
banks that where once deemed ‘Too Big to Fail’. In the UK this has led to the Publication of
new requirements and guidance from the bank of England. The core shift caused by these
changing regulations is the onus being placed on the Shareholders and investors of Banks to
bear the losses and costs of recapitalisation when a failure occurs. Failing that the Bank of
England believes that it now has the necessary legal powers to manage the failure of a Bank
and use investor funds to keep a bank going in the interim should it need to be sold off or
broken up [5]. Effectively the Bank of England hopes that foresight of what can happen when
a bank deemed ‘Too big to Fail’ does fail, will help avoid situations where their hand is
forced, and they have to take action. A situation which took place with the failure of RBS
where then Chancellor Alistair Darling said that RBS were within a couple of days of having
to shut down its ATM machines as it was about to run out of cash. This would have caused
substantial civil unrest and riots as was the case in Greece at the time when people were
unable to access their money [6][7]. Though we won’t know how effective these changes in
regulation are until a major UK bank actually fails, it is regardless a positive change for
regulations and should allow more flexibility to do something other than simply bail out these
banks when such a crisis occurs.

It’s seemingly easy to see how a culture of too big to fail has arisen but nonetheless it comes
with its unique set of problems and drawbacks. To begin with there is the risk factor, if a
bank can operate under the pretences that if it takes too big a risk and loses too much money
then it will be saved from itself regardless, then why wouldn’t it take that risk. [8] Effectively
there is no downside to overextending or making the wrong call when investing as they’ll be
fine regardless. This would likely cause them to take riskier and riskier decisions until they
are no longer bailed out. Another issue with the concept of Too Big to Fail is the way in
which it seemingly contradicts the concept of a free competitive market. In a true free market
businesses must be allowed to fail. The Too Big to Fail attitude to banks creates two classes
of bank and contradicts any possibility of a level playing field. Furthermore, taking the idea
of Too Big to Fail to its extremes would mean that banks deemed TBTF would stay that way
and smaller banks would have little to no opportunity to become TBTF…

[5] ‘Resolvability Assessment of Major UK Banks: 2022’ [6] ‘Greek Crisis: How Did It Get This Bad?

[7] ‘Greece’ (World Bank Open Data) [8] ‘Macroeconomics’ (StudySmarter UK)

…This is because the risks that the large banks would be able to take, as well as the
advantage of their already bigger pool of liquidity, would make even the shrewdest smaller
banks too disadvantaged to ever catch up. Next, there is the issue of reliance on these TBTF
banks, this is because as these banks are more and more protected while others are not, they
would grow and grow, and thus if they were to eventually fail beyond a bailout then the
fallout from such a failure would have an even greater impact on their domestic economy
than before.

Though clear drawbacks can be seen in the way that a Too Big to Fail attitude can affect the
actions taken why banks, I believe that it is nonetheless a necessity to ensure global financial
stability. This is because of a number of reasons, to begin with there is the obvious issues that
arise with civil unrest due to funds not being available to customers, as well as personal and
business loans being recalled leading to poverty and higher unemployment as businesses
begin to fail. But beyond that there are other reasons why a Too Big to Fail attitude may be
the right choice, for example, we should examine the cost to the UK Government in the event
of a systemically important bank failing. One of these would be that of gilts earned by UK
banks [9]. In the event of a bank which owns a substantial amount of Treasury Bonds fails,
these bonds like all holdings would hit the market, the nock on effect of this would be a
devaluation of other Government Bonds as well as bonds that are released in the future being
devalued. This would likely have a greater detrimental effect on the UK Govs ability to
borrow money and on the UK economy than perhaps the bailouts themselves. A further cost
to the UK Gov that would result from a large bank failing would be the cost to the PPF
(Pension Protection Fund), a government scheme which guarantees all pensions and
annuities. This means that upon the failing of a bank which provides a large number of
Annuities [10] there would be an immense cost to the UK Government regardless of whether
intervening action was taken to keep it alive or not. Another issue arising from deciding not
to save a bank deemed too big to fail is the effect on competition in the field. As banking is a
field already dominated by a few large banks holding most of the market share, if one of
these larger banks where to fail the customers moving over to the other big banks would
produce an even less competitive market which would ultimately hurt consumers in their
choice and value. Finally, we should consider what is asked of larger banks because of their
position as ‘Too Big to Fail’…

[9] Coles TJ, ‘Who Owns Our National Debt? It’s a Secret! [10] (Q4 2023 consensus financial estimates -
investors.rbs.com)
…For example in March 2023 when Silicon Valey bank failed in the US, the Bank of
England stepped in to facilitate the sale of its UK operations to HSBC.[11] In doing this
HSBC ensured that their services could continue as normal and customers could access their
deposits, which were now guaranteed by HSBC, this also ensured that a Number of UK tech
firms were able to remain in business and ultimately constituted no cost to the UK tax payer.
[12] Similarly also in March 2023 the merger of UBS and Credit Suisse happened without the
approval of UBS shareholders as the Swiss Financial Market Supervisory Authority FINMA
intervened to save credit Suisse. Because of this it seems that it is less the case of smaller
banks being allowed to fail while big banks are saved by bailouts, but rather smaller banks
can be absorbed into their larger counterparts while this is not an option for the biggest banks,
and thus the government is forced to act.

In conclusion, though it’s hard to get behind the concept of Too Big to Fail as it seems to
reward callousness as well as contributing to a lack of competition and ushering in an
oligopoly within banking, I think that nevertheless it is a necessary evil. I believe that the
easiest way to evaluate this is to look at what would happen if the government failed to
bailout these banks. I believe that the cost to government regardless, as well as the usefulness
of these banks in their TBTF position, being that they’re able to take over for the smaller
banks when they fail, means that their bailouts are more than justifiable. Furthermore, I
believe that it is the governments responsibility to protect the interests of its citizens, and
though blank checks being written to bailout banks mistakes it a tough pill to swallow, it
would be a much worse situation if customers were to lose their personal savings due to a
bank’s collapse. Finally, I believe that the idea of TBTF that we have now is vastly different
to that of the past. This is because, per the Bank of England guidance and the requirements
set out for G-SIBs, the bailout as we knew it is dead. Now, rather than taxpayer money being
used, the banks will be held responsible for their own survival and shareholder funds will be
called upon. Though we won’t fully know how the Government will react when a TBTF
Bank fails beyond their own funds being able to save them, we must take at face value, at
least for now, their promises that callousness will not be rewarded as it may have been in the
past. Because of this I view TBTF as a necessary evil with a new attitude which if successful
will act as a helpful compromise between blank checks of government intervention and an
unaided free market.

[11]’ ‘What Happened to Silicon Valley Bank UK?’

[12] Race M, ‘HSBC Swoops in to Rescue UK Arm of Silicon Valley Bank’.

Bibliography
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