Question

What is a SIFI and how does it related to “too big to fail”? Describe the “too big to fail” debate.

Answer 1

SIFIs (Systematically Important Financial Institutions) are the financial institutions which are the important part of the economy and the failure of these institutions result in economic and financial crisis.

When the financial institutions are very large in size that its failure may result in huge financial crisis, the government take necessary steps to provide necessary strength to the institution that it may not fail.

The main motive of SIFIs rules was to cater to the systematic risks and the moral hazard problems of the institutions which were seen in the markets as “too big to fail”. The SIFIs were also called as banks which are too big to fail. Around 29 banks were categorized as SIFIs. The regulations led to higher incentive for the banks to take risks. The government decided to bail out the creditors to prevent the economy after financial failure. The institutions become too leveraged and go for more credit, maturity, and liquidity. SIFI plan includes additional loss absorption capacity, greater supervision, and institution specific cross border cooperation agreements etc.

The too big to fail banks supports the economy but also have lot of risk for the financial failure having devastating impact on the economy. During 2008 crisis, the government bailed the creditors to save the banks from failure. This helped the banks to strengthen its condition and improve the profitability. These institutions had capacity to serve the customers throughout USA and with the low costs because of their huge size. This has resulted in the growth in the economy.