The Governance of 'Too Big to Fail' Banks

Abstract:     
This paper considers possible and proposed responses to the “To Big (complex, interconnected, important) To Fail (TBTF) Problem.” It argues that the corporate governance of large shareholder-owned deposit taking banks is particularly problematic because of the implicit insurance their shareholders and bondholders enjoy, at the taxpayers expense. This creates issues of moral hazard and also competitive inequality, because TBTF banks can raise funds more cheaply than non-TBTF banks. The US pre-funded deposit insurance scheme with risk-related premia does a pretty good job managing the moral hazard issues relating to non-TBTF banks. A parallel mechanism involving a special resolution regime for TBTF banks and the equivalent of deposit insurance with risk-related premia needs to be put in place. Whether the scheme should be pre-funded or operated on a ex post ‘polluter pays’ basis, and the associated tax regime for TBTF banks needs further consideration. Bondholders should not enjoy the current level of protection and "Co-Co" bonds may be part of the solution. Consumer Protection is a good idea and deposit taking banks should be regulated as other "utilities" are in the UK. The corporate governance problem would be simpler if all retail deposit taking banks were mutuals!

Number of Pages in PDF File: 28

Keywords: Corporate Governance, Depository Institutions

JEL Classification: G21, G28, G53

working papers series