Re-structuring the Financial Sector to Reduce its Burden on the Economy

The financial crisis of 2007–09 has, unsurprisingly, raised a whole raft of questions about the future of the financial sector, usually focusing on the regulation of the financial sector as a route through which future financial crises may be avoided — or which would at least mitigate the effects of such events. Parts of the debate over regulation have touched on issues of the separation of functions between financial institutions, and of ensuring that banks and other financial institu-tions are not ‘too big tofail’. In this chapter we start with the remarks that the financial sector has grown (relative to the rest of the economy) in the past two to three decades, and consider the roles and purposes of the financial sector. This leads into a consideration of whether the increased resources devoted to the financial sector have been matched by comparable increases in the benefits derived from the financial sector. It is then argued that the financial crisis and the recession, which is seen as arising from the behaviour of the financial sector, also imposes some substantial costs, which are sketched. In the final section we discuss three aspects of ways of re-structuring the financial sector in ways which would reduce its burden on the macroeconomy. First, how to deal with the ‘too big tofail’ issue which creates moral hazard issues not to mention the costs associated with rescue packages.