This post comes to us from Karen Petrou, co-founder and managing partner of Federal Financial Analytics, Inc., and is based on a presentation of a paper written by Ms. Petrou; the full text, including citations, is available here.
A critical policy question is the extent to which “systemic” banks provide value from an economic or social perspective. Much research has been mobilized to demonstrate this, as well as to counter these findings to argue that the biggest banks enjoy undue subsidies because they are so systemic as to be protected by taxpayers. Markets may indeed perceive some big banks as too big to fail (TBTF), but perception does not make reality. Thus, this paper assesses how a systemic financial institution can be differentiated from others to inform the debate over policy responses to TBTF and pending regulatory actions and U.S. legislation to govern the largest financial institutions. Quite simply, if there are no reliable, objective systemic criteria, then policy based on size thresholds or other “systemic” indicators will be at best ineffective antidotes to global financial crises even as they do unnecessary damage to banks and, more broadly, to financial-market efficiency and effectiveness.
In this paper, we assess the ability of regulators to define the criteria that characterize systemically-important financial institutions (SIFIs). The definition of systemic is critical since an array of rules predicated on the negative externalities of SIFIs is under active development. Further, allegations that “systemic” firms, most notably very large bank holding companies (BHCs), are TBTF have aroused calls for additional, generally punitive action for designated institutions.