NY Fed Chair – Ending Too Big to Fail

by Sabrina I. Pacifici on November 7, 2013

William C. Dudley, President and Chief Executive Officer - Remarks at the Global Economic Policy Forum, New York City, November 8, 2013

“..My remarks are going to focus on what is called the “too big to fail” problem.  As you are aware, this problem arises when the failure of a large, complex financial institution threatens to cause such significant disruption to the financial system and the economy that these potential costs are judged as too severe to bear, leading to government intervention to prevent the failure.  As a result, the firm, by being too big to fail, gains an implicit guarantee at the taxpayers’ expense that it does not have to pay for.  I think there is broad agreement that such a regime is unacceptable in several respects.  The first problem is that it creates an uneven playing field between large and small financial firms, with larger financial firms gaining a funding advantage from the perception that they may be too big to fail.  The second problem is that this funding advantage creates incentives for financial firms to become bigger and more complex.  The third problem is that there is a positive feedback loop.  As the banking system becomes more concentrated and complex, that just increases the financial stability risks, making the too big to fail problem even more acute…To summarize, I conclude that building a credible resolution regime is necessary but not sufficient.  Even if the single-point of entry resolution framework proposed by the Federal Deposit Insurance Corporation (FDIC), which I very much endorse, is fully perfected, the costs of resolution for the largest systemically important financial institutions (SIFIs) will still be significant.  I will argue that at least as much effort should be made to lower the risk of failure of such large, complex firms.  Not only does this include higher capital and liquidity requirements, which we are implementing, but also building incentives into the system so that firm managements will act more forcefully and much earlier to put their firms on more solid ground before they encounter greater difficulties.”

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