Progress on Addressing 'Too Big To Fail' Progress on Addressing 'Too Big To Fail'

February 4, 2016

Boston Fed President Eric Rosengren discussed progress in the U.S. on eliminating the "Too Big to Fail" phenomenon Thursday. He focused on two areas of progress since the financial crisis—increased capital buffers aimed at reducing the probability of failures, and steps to reduce the spill-over of problems from one troubled institution to others and the financial system.

Rosengren noted that a number of the largest institutions have grown over the past five years. But it may be too soon to judge what size organizations are likely to be once the full set of regulations is implemented. He said the most important progress to date on Too Big to Fail involves reducing the probability that these institutions will fail—and should they fail, reducing the risks they would pose to the entire economy.

Of the regulatory initiatives designed to reduce the probability of failure, Rosengren called the introduction of stress testing that examines the ability of large bank holding companies to withstand stressful economic and financial conditions "perhaps the most crucial change" to the supervision of large financial institutions. He also pointed to regulatory changes that have significantly altered the capital regulation of Global Systemically Important Bank Holding Companies or "GSIBs" and specifically the GSIB capital surcharge, which is designed to reflect the systemic risk posed by these organizations because of the size and complexity of their operations.

"The effect of [these regulations] is to significantly reduce the probability that a GSIB fails," Rosengren said. "The combination of these and other capital regulations (as phased in) should result in a significant improvement in capital ratios for GSIBs."

Rosengren also highlighted actions to try to reduce the cost if—despite stress tests and enhanced capital regulations—a GSIB were still to fail. He discussed the proposed rule for total loss-absorbing capacity, saying that its purpose is to "insure that if a GSIB were to fail, sufficient debt financing would have been employed so that taxpayer resources would not be needed in order to resolve the institution." In addition, Rosengren noted that GSIBs are required to develop resolution plans or so-called "living wills," covering how they could be resolved. Ratings agencies are viewing these actions as "significantly reducing the Too Big to Fail problem."

Rosengren's talk also briefly touched on a number of other areas of progress, including a shift in the clearing of some derivatives to central counterparties; the application of regulations to non-bank, systematically important financial institutions; steps to increase the resiliency of large foreign banking organizations by requiring them to form intermediate holding companies, subjecting them to stress testing requirements and the same capital standards as their U.S. counterparts; and the establishment of new regulatory tools intended to make financial firms more resilient to liquidity shocks.

In all, Rosengren cited progress, while noting the significant work still remaining.

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