26/12/2019 Too Big to Fail Definition

ECONOMY GOVERNMENT & POLICY

Too Big to Fail

By JULIE YOUNG | Updated Apr 30, 2019

What Is Too Big to Fail?

"Too big to fail" describes a concept in which the government will intervene in situations
where a business has become so deeply ingrained in the functionality of an economy that its
failure would be disastrous to the economy at large. If such a company fails, it would likely
have a catastrophic ripple effect throughout the economy.

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The failure may cause problems with companies which rely on the failing company's
business as a customer as well as problems with unemployment as workers lose their jobs.
Conceptually, in these situations, the government will consider the costs of a bailout in
comparison to the costs of allowing economic failure in a decision to allocate funds for help.

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Too Big To Fail

Too Big to Fail Financial Institutions

The “too big to fail” colloquialism centers around the idea that certain businesses, such as
the biggest banks, are so vital to an economy that it would be disastrous if they went
bankrupt. To avoid a crisis, the government can provide bailout funds which support failing
business operations, protecting companies from their creditors and also protecting
creditors against losses.

Those financial institutions which fall into the "too big" category include banks, insurance,
and other finance organization. They carry the identifier of being systemically important
banks (SIBs) and systemically important financial institutions (SIFIs). These financial
organizations received regulation under the Dodd-Frank Wall Street Reform and Consumer
Protection Act of 2010.

KEY TAKEAWAYS
Too big to fail is a colloquialism applied to the theory that some businesses would
cause widespread damage to the economy if they fail.
Under this concept, the government will intervene in situations where failure
threatens the economy at large.

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Key regulations post-crisis include the Emergency Economic Stabilization Act of

2008.
The Emergency Economic Stabilization Act included the $700 billion Troubled Asset
Relief Program (TARP), the Dodd-Frank Act of 2010 and new global Basel standards. 

Background on Bank Reform

Following the bank failures of the Great Depression, deposit insurance and regulators, such
as the Federal Deposit Insurance Corporation (FDIC), were created to step in and efficiently
insure customers while also participating in the bank liquidation process if necessary. As
such, FDIC-insured deposits helped Americans to be confident in their deposits of money
into the banking system. FDIC reforms also promoted saving for the future covering
individual accounts in member banks up to US$250,000 each.

While this government regulation has been effective for U.S. depositors, a lack of extended
fail-safes into the broader corporate world became evident in a new financial crisis surfacing
near the beginning of the 21st century. In 2007 and 2008, deeply indebted banks without
FDIC protection faced failure. These institutions were responsible for collectively loose and,
in some cases, even fraudulent lending practices across the financial industry which caused
widespread defaults. 

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Lehman Brothers’ collapse marked the peak of the financial crisis in September 2008. With
its bankruptcy filing, government regulators discovered the biggest banking firms were so
interconnected that only large bailouts would prevent a substantial portion of the financial
sector from failing.

As a result, the government enacted the Emergency Economic Stabilization Act (EESA) of
2008 which was signed in October 2008. Central to the Act was a $700 billion Troubled Asset
Relief Program (TARP) to be managed by the U.S. Treasury for the purpose of helping
distressed banks.

Important: Too big to fail became a common phrase during the 2008 Financial
Crisis, which led to widespread financial sector reform in the U.S. and globally.

Dodd-Frank Act
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 followed the
Emergency Economic Stabilization Act and was created to instill new regulations that would
help to avoid future bailouts. This included new requirements for capital holdings and
increased capital reporting for regulatory review. Banks are now required to have specific
capital levels and to create living wills outlining how they would liquidate assets quickly if
filing for bankruptcy.

Dodd-Frank also imposed higher requirements for banks collectively labeled systemically
important financial institutions (SIFIs).

Global Banking Reform

The 2008 financial crisis was a global crisis that affected banks around the world. Worldwide
regulators also instilled new reforms with the majority of new regulations focused on too big
to fail banks. Global banking regulation is primarily led by the Financial Standards Board in
conjunction with the Bank for International Settlements and the Basel Committee on
Banking Supervision. Examples of some international companies considered global
systemically important financial institutions include:

Mizuho
Bank of China
BNP Paribas
Deutsche Bank

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Credit Suisse

Real World Example

These SIFIs are identified as America’s too big to fail banks by their total assets and have
higher reporting standards to ensure their operational efficiency. As of 2019, these
companies include:

Bank of America Corporation

The Bank of New York Mellon Corporation
Barclays PLC
Citigroup Inc.
Credit Suisse Group AG
Deutsche Bank AG
The Goldman Sachs Group, Inc.
JP Morgan Chase & Co.
Morgan Stanley
State Street Corporation
UBS AG
Wells Fargo & Company

Related Terms
Systemically Important Financial Institution (SIFI) Definition
A systemically important financial institution (SIFI) is a firm that regulators determine would pose a
serious risk to the economy if it were to collapse. more

Emergency Economic Stabilization Act (EESA) of 2008

Emergency Economic Stabilization Act (EESA) of 2008 was passed by Congress to help repair the
damage from the financial crisis of 2007-2008. more

Purchase and Assumption (P&A)

A purchase and assumption is a transaction in which a healthy bank or thrift purchases assets and
assumes liabilities from an unhealthy bank or thrift. more

Privatizing Profits And Socializing Losses

Privatizing profits and socializing losses recognizes company earnings as shareholder property and
losses as the responsibility of society. more

Did the Troubled Asset Relief Program (TARP) Save the Economy?
The Troubled Asset Relief Program (TARP) created and run by the U.S. Treasury following the 2008
financial crisis, to stabilize the financial system. more
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Bailout Money Helps Failing Businesses and Countries

A bailout is an injection of money from a business, individual, or government into a failing company to
prevent its demise and the ensuing consequences. more

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