Too Big to Fail Banks: Examining the 'How' of Breaking Up

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Too Big to Fail Banks: Examining the 'How' of Breaking Up

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Title: Too Big to Fail Banks: Examining the 'How' of Breaking Up
Author: Singh, Aditi
Citation: Aditi Singh, Too Big to Fail Banks: Examining the 'How' of Breaking Up (May, 2013).
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Abstract: The newfound understanding that systemic risk is the central problem of financial regulation, has informed both institutional and regulatory responses to the global financial crisis. At the forefront of the systemic risk debate is the problem of too-big-to-fail, which has become increasingly intractable as a result of little analytical certainty and myriad policy options. Dodd Frank proposes several structural, behavioral and conduct based regulatory tools to counteract the financial industry’s incentives to assume significant risks and to provide a solution to the systemic risk problem. This article examines the policy solution of limiting the size of too-big-to-fail banks, specifically the issue of breaking up a bank that exceeds a certain size threshold. Breaking up of banks is an idea that has started to gain increasing traction from politicians, regulators and financial analysts alike. However, the debate so far has failed to address fundamental questions relating to how the break up is to be achieved. This article attempts to venture into the hitherto unexplored territory of the manner of breaking up of a too-big-to-fail bank, without examining the merits of whether the breakup itself is advisable or not. The article develops a three-pronged approach to address this question. First, it examines how shifting regulatory and investor perspectives, in the milieu of a fragile economic environment, have prompted banks to downsize. Second, it analyzes the first-order questions that need to be answered to determine the manner of breaking up, including, questions relating to relevant size, entity and jurisdictional concerns. Third, it presupposes a situation, where a political commitment to breaking up of too-big-to-fail banks has been made and subsequently proposes a paradigm to enable the same. The ‘break-up’ paradigm is based on the ‘functional divestiture’ model under anti-trust laws and seeks to create an optimal and administrable way of breaking up a too-big-to-fail bank with minimum disruption to the financial system. This article makes a case for addressing the complexities regarding the manner in which a too-big-to-fail bank is to be broken up, so that the political maneuvering and regulatory strategies regarding potential cost-benefits of different break-up mechanisms are better informed.
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