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Too Big to Fail: Causes, Consequences, and Policy Responses

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  • Philip E. Strahan

    () (Carroll School of Management, Boston College, Chestnut Hill, Massachusetts 02467
    The National Bureau of Economic Research, Cambridge, Massachusetts 02138)

Abstract

Governments cannot credibly commit to eschew bailouts of creditors when large financial institutions become distressed. This too-big-to-fail (TBTF) problem distorts how markets price securities issued by TBTF firms, thus encouraging them to borrow too much and take too much risk. TBTF also encourages financial firms to grow, leading to competitive inequity and potential misallocation of credit. This review discusses evidence that such distortions are empirically relevant and also discusses the policy efforts to limit them. In the wake of the Financial Crisis of 2007–2008, it seems increased concentration in the financial industry has worsened the TBTF problem. Nevertheless, markets price the risks of large financial firms more now than before the Financial Crisis.

Suggested Citation

  • Philip E. Strahan, 2013. "Too Big to Fail: Causes, Consequences, and Policy Responses," Annual Review of Financial Economics, Annual Reviews, vol. 5(1), pages 43-61, November.
  • Handle: RePEc:anr:refeco:v:5:y:2013:p:43-61
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    File URL: http://www.annualreviews.org/doi/abs/10.1146/annurev-financial-110112-121025
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    Cited by:

    1. Stijn Claessens & Neeltje van Horen, 2015. "The Impact of the Global Financial Crisis on Banking Globalization," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 63(4), pages 868-918, November.
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    3. Rajkamal Iyer & Thais Jensen, & Niels Johannesen & Adam Sheridan, 2016. "The Run for Safety: Financial Fragility and Deposit Insurance," EPRU Working Paper Series 1602, Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics.
    4. Fabio Schiantarelli & Massimiliano Stacchini & Philip E. Strahan, 2017. "Bank quality, judicial efficiency and borrower runs: loan repayment delays in Italy," IFC Bulletins chapters,in: Bank for International Settlements (ed.), Uses of central balance sheet data offices' information, volume 45 Bank for International Settlements.
    5. Götz, Martin & Krahnen, Jan Pieter & Tröger, Tobias, 2017. "Five years after the Liikanen Report: What have we learned?," SAFE White Paper Series 50, Goethe University Frankfurt, Research Center SAFE - Sustainable Architecture for Finance in Europe.
    6. Acharya, Viral & Anginer, Deniz & Warburton, Joe, 2016. "The End of Market Discipline? Investor Expectations of Implicit Government Guarantees," MPRA Paper 79700, University Library of Munich, Germany.
    7. McAndrews, James J. & Morgan, Donald P. & Santos, Joao A. C. & Yorulmazer, Tanju, 2014. "What makes large bank failures so messy and what should be done about it?," Economic Policy Review, Federal Reserve Bank of New York, issue Dec, pages 229-244.
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    More about this item

    Keywords

    bank risk; too big to fail;

    JEL classification:

    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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