Overcoming Too-Big-To-Fail: A Regulatory Framework to Limit Moral Hazard and Free Riding in the Financial Sector

CEPS Task Force Reports

104 Pages Posted: 19 May 2010

See all articles by Jacopo Carmassi

Jacopo Carmassi

European Central Bank

Elisabetta Luchetti

affiliation not provided to SSRN

Stefano Micossi

Associazione italiana delle società per azioni

Date Written: March 15, 2010

Abstract

Following the demise of Lehman Brothers, the debate on regulatory reform has been misled into concluding that large financial institutions must be broken up and their risk-taking activities limited by law, as called for by the ‘Volcker rule’. This report of a joint CEPS-Assonime Task Force argues that such actions are by no means necessary, may be hard to implement in practice and could entail large costs in terms of the availability of credit to the economy (e.g. if they reduced the ability of banks to hedge their credit positions). Alternative solutions exist that can achieve a more stable and resilient financial system without renouncing the benefits of multi-purpose financial institutions and innovative finance. These are predicated on effectively curtailing moral hazard and strengthening market discipline on banks’ shareholders and managers by raising the cost of the banking charter to fully reflect its benefits for the banks, and restoring the possibility that all or at least most financial institutions could go bust without triggering unmanageable systemic repercussions. The authors outline a comprehensive framework for regulating cross-border banking groups.

Keywords: financial institutions, cost, credit, economy, bank, financial system, market

Suggested Citation

Carmassi, Jacopo and Luchetti, Elisabetta and Micossi, Stefano, Overcoming Too-Big-To-Fail: A Regulatory Framework to Limit Moral Hazard and Free Riding in the Financial Sector (March 15, 2010). CEPS Task Force Reports. Available at SSRN: https://ssrn.com/abstract=1610214

Jacopo Carmassi (Contact Author)

European Central Bank ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Elisabetta Luchetti

affiliation not provided to SSRN

Stefano Micossi

Associazione italiana delle società per azioni ( email )

Piazza Venezia 11
ROMA, 00187
Italy
+39 06 69529214 (Phone)

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