OTTAWA, March 2 /CNW Telbec/ - Governments should limit the systemic risks posed by organizations deemed "too big to fail"-those whose failure would cause severe damage to the financial system, a particular market, or a country's entire economy, argues a new Conference Board of Canada briefing released today.
"Reducing red tape for businesses is generally considered good practice. However, the economic events of the past two years suggest that the status quo is not good enough," said Michael Burt, Associate Director. "During the recession, governments bailed out several organizations because they were considered to be 'too big to fail'. Given the fiscal burden put on governments by having to rescue these companies, it makes sense to reduce the risks that "too large" organizations pose."
Organizations considered "too big to fail" are essentially free to take risks and reap any rewards, while passing on the risk of business-ending activities to taxpayers. This mismatch between risk and reward can lead to organizations taking unnecessary risks or having inadequate risk management practices.
If the failure of large institutions can be catastrophic for a country, then the state has a responsibility to take out an insurance policy against failure, through increased regulatory oversight. Some steps for creating such an insurance policy include:
- Defining the parameters of what poses a systemic risk to the country -
Measures such as a company's direct and indirect share of national
employment, its market share, and the size of its contribution to the
country's fiscal purse should be considered.
- Creating "living wills" for organizations - Establishing a contingency
plan to deal with a company's failure would allow some consistency in
policy. It would also allow stakeholders to understand what they would
lose in the event of failure.
- Designing industry specific risk control measures - Similar to capital
requirements for banks or covenants on debt, these would prevent the
failure of an organization under foreseeable circumstances.
- And possibly, breaking up firms that are deemed "too big to fail" -
This may not be a practicable solution in many circumstances, but it
is a policy option that regulators have used in the past for other
This publication, Lessons from the Recession and Financial Crisis: Lesson 4: "Too Big to Fail" Means Too Big, is the part of the Conference Board's ongoing series on lessons from the recession and financial crisis. The Conference Board's Forecasting and Analysis team has examined the developments of the past year and has drawn key lessons for the world and for Canada that deserve priority discussion among policy makers and business leaders.
SOURCE Conference Board of Canada
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