The Too-Important-to-Fail Conundrum: Impossible to Ignore and Difficult to Resolve

International Monetary Fund

Executive Summary

The recent financial crisis has higlighted the “moral hazard” problems associated with systematically important financial institutions (SIFIs). Because of the scale of their activities and interlinkages with other institutions and the market, they are able to propagate distress to the broader financial system. As a result, policies have to be developed to reduce the likelihood of financial institution failures and make them less devastating when they occur. The elements of an adequate policy framework to deal with the Too-Important-to-Fail problem should include the following:

• More stringent capital (and possibly liquidity) requirements to limit contribution to systemic risk

• Intensive supervision consistent with the complexity and riskiness of SIFIs

• Enhanced transparency and disclosure requirements to capture emerging risks in the broader financial system, and

• Effective resolution regimes at the national and global level to make orderly resolution a credible option, with resolution plans and tools that lead creditors to share any losses.

While some important issues are currently under developement, implementation is expected to take several years. Among the key issues that require rapid progress are:

• The methodology to identify SIFIs

• The level, composition, and coverage of a capital surcharge

• Institutionalizing international standards for intensive supervision of SIFIs and translating them into national practices

• Enhancing disclosure, addressing data gaps, understanding shadow banks, and achieving consensus on cross-border resolution and information sharing arrangements.