Too Big to Fail

The concept gained wide attention during the 2008 financial crisis, when governments spent large sums rescuing major banks and insurers whose failure could have triggered a chain reaction across the financial system.

The problem is that if large institutions believe they will be rescued, they may take greater risks, knowing that they keep the profits when things go well while taxpayers bear the losses when things go wrong. This is an example of moral hazard. Their perceived government backing may also allow them to borrow more cheaply than smaller competitors.

For example, a large global bank with trillions in assets, connections to thousands of other financial institutions and millions of customers might be considered too big to fail.

Since 2008, regulators have tried to reduce the problem. The largest banks, designated as systemically important, must hold extra capital, undergo regular stress tests and prepare plans, sometimes called living wills, showing how they could be wound down without taxpayer support. Bail-in rules require shareholders and certain creditors to absorb losses before any public money is used.