Breaking Up Banks and Financial Institutions That Are “Too Big to Fail”

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National Research University Higher school of economics The Theory of Money, Banking and Financial Markets Breaking up Banks and Financial institutions that are “Too Big To Fail” Moscow 2011 Large financial institutions generally do business with a lot of other companies. If such company fails, other companies, employees, investors, counterparties will get hurt. It can be disastrous to an economy. It’s an idea of definition for financial institutions that “Too Big To Fail”. The precise definition is that TBTF companies are certain financial institutions that are so large and so interconnected that their failure will have a disastrous effect throughout the economy. So, if the cost of a bailout is less than the cost of the failure to the economy, a government will provide assistance to prevent its failure. An important point is that "too big to fail" doesn't mean that a financial institution can’t fail, but that it can’t be allowed to do so. Why TBTF institutions appear? The advantages are obvious. It is thought that such institutions take positions that are high-risk, as they are able to leverage these risks based on the policy preference they receive. So, a government would intervene to prevent its failure or, at least, limit the losses to uninsured creditors upon failure, if a large organization were to get in trouble. In general, a bank tends to become larger and riskier if its uninsured creditors believe that they will benefit from TBTF policy. The next issue is a role of TBTF institutions. Firstly, some businesses that are so large can make up a significant part of an economic sector. So their failure could cause the sector to crash and damage the economy. Secondly, the failure of TBTF companies has the potential to take other businesses down with them, as all companies maintain relationships with partners. When a major source of orders disappears, a

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