MANAGING THE EXPANDED SAFETY NET

Overall confidence and stability in the financial sector has been preserved throughout the period of the global financial crisis, underpinned by a strong financial sector and negligible exposure to subprime-related assets and affected counterparties. The greatest risks posed to banks by the slowdown of economic growth take the form of credit risks. So far, the number of loans in default is still relatively small, but it is increasing and is expected to grow two or threefold. The first signs of this can already be seen in the number of bankruptcies declared, which is rapidly increasing.

Too big to fail (TBTF) is the concept to integrate to thefinancial crisisof the late 2000swhen the U.S. government disbursed $700 billion to save companies, such as AIG, that were on the verge of financial failure.The bigger the government safety net, the more the government shifts risk from creditors of financial firms to taxpayers. With less to lose, creditors have less incentive to monitor financial firms and to discipline risk-taking.

Now, this dulling of the depositors' senses has the welcome effect in our example of stopping runs on the largest banks but at the same stickiness of deposits has a major downside. The large bank that fleeing depositors would otherwise close remains open to continue or increase its risky bets. If it does not get lucky, the bank's losses actually grow. In this way, the safety net encourages risk-taking that exposes society to increasing losses, with their associated instability.

Prior to the crisis, numerous academic studies and banking textbooks discussed the too-big-to-fail problem and moral hazard more generally. However, for those who have written about these issues for many years, the true depth and seriousness of the concerns were only revealed during the recent financial crisis. It is surprised to hear the occasional voices which claim that the too-big-to-fail problem is overstated. It is imperative that we not only cope with the too-big-to-fail problem, but that we also deal with it effectively. The capital surcharge for global systemically important banks introduced by the Basel Committee is a significant step in the right direction. The same is true of the progress on improving recovery and resolution planning.

QUESTION 1

What is Safety Net for Banking? (10 marks)

QUESTION 2

What do you understand about Too Big To Fail (TBTF)? (10 marks)

QUESTION 3

In the light of such uncertainty and measurement problems, what are the objectives of regulatory policies developed to address the too-big-to-fail problem? (10 marks)

QUESTION 4

In your opinion, what is the best solutions to change the expectations of bailouts? (10 marks)

QUESTION 5

List three approach should policymakers do to address concerns over spillovers? (10 marks)