Financial regulators anxious to avoid a replay of the 2008 financial meltdown have set up more stringent rules around capital retention and asset quality for the world’s largest banks, which have now been designated as SIFIs (or Systemically Important Financial Institutions). But does officially being labeled “important” actually increase (rather than decrease) moral hazard?
One purpose of the effort is to avoid another Bear Stearns, the investment bank that collapsed and tripped the wire for the 2008 global financial meltdown.
The G20 asked the Financial Stability Board (FSB) to create the new SIFI designation. As the FSB puts it, “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.” Such banks thus are often called, unofficially, “too big to fail.” Some 29 banks have received a global SIFI designation.
Regulators hope tougher regulations will lessen the moral hazard that can infect large banks deemed too big to be allowed to fail. But, as Wharton finance professor Itay Goldstein notes, “… now that this bank knows that it is a SIFI … and it is essentially too big to fail, then maybe the bank will have a higher incentive to take risks. Now all of the counterparties doing business with the bank will know that, and as a result they will govern it less and require a lower cost of capital….”
Knowledge@Wharton looks at this issue in a just-released video titled, “The Tension between ‘Too Big to Fail’ and Moral Hazard Continues,” made in collaboration with Ernst & Young. The latest video is part of a new series on how SIFI Rules Are Recasting Global Banking, which in turn is part of an ongoing effort to cover global banking — “Global Banking: Foresight and Insights.”