On being the right size

This paper discusses the too-big-to-fail problem from the perspective of individual banks and the financial system as a whole. It starts by exploring the potential implications of recent financial deepening and concentration, which has generated escalating expectations of state support, thereby encouraging further expansion and concentration. The paper then explores three policy approaches to tackling the too-big-to-fail problem. The first is the imposition of systemic surcharges of additional capital, which have the effect of reducing expected system-wide losses in systemically important banks, but not materially so at current levels of the surcharge. Second, new resolution regimes are being put in place to allow banks to fail safely — though the market still has doubts about their credibility for the biggest banks. Finally, structural reform of banks is taking place, through proposals by Volcker, Vickers and Liikanen. Despite this policy progress, expectations of state support remain high. This paper proposes potential additional reforms to tackle too-big-to-fail, such as placing limits on bank size and market share and increasing competition. While existing initiatives are a step in the right direction, there may be some distance to travel before banking is the right size.