Question

"Too big to fail financial institutions are both beneficial and harmful to the global economy." Please explain how is the above statement true and why? Provide some detailed examples as part of your argumentation. (200 - 500 words should be enough to provide a complete answer)

Answer 1

Big financial institutions are beneficial to the global economy as they are able to provide financial intermediation at a large scale and hence can lower the overall cost of funds and thus can provide an impetus for economic growth. Moreover, by having a large presence across geographies, these institutions generate a lot of employment as well. Additionally, big financial institutions help in forming structures for banking across borders and aid in financial inclusions. They also help in financial innovation and introducing newer products as per risk and return expectations.

The disadvantages of big financial institutions are that there could be a loss of prudent risk control and this may result in tail risks surfacing such as those seen during sub- prime crisis. Due to their large size, any contagion can potentially affect the entire economy and have catastrophic results. Moreover a status of too big to fail might make management complacent since they feel that the firm would be bailed out by government in case of any risks appearing and thus this feeling dilutes the fiduciary responsibility.