Last updated: March 31, 2014 7:47 pm

Problem of banks seen as ‘too big to fail’ still unsolved, IMF warns

International Monetary Fund©Getty

The world’s largest banks still receive implicit public subsidies worth as much as $590bn because of their status as “too big to fail” and the assumption of a government bailout if they get into trouble, the International Monetary Fund warned on Monday.

The warning, to be included in the fund’s twice-yearly Global Financial Stability Report, highlights the failure of post-financial crisis reforms to solve the problem of too-big-to-fail despite a vigorous lobbying campaign by the largest banks claiming it is no longer an issue.

The IMF report showed that in the event of another financial crisis and in the absence of new reforms, taxpayers could still be liable for hundreds of billions of dollars of support for banks.

The implicit subsidies take the form of the benefits that accrue to banks and their investors because of the bailout assumption. If bankers know the government is likely to bail them out, they may take more risk. In addition, investors are willing to lend to such banks at lower cost because they see the likelihood of a bailout as a form of insurance. This creates an effective subsidy for the biggest banks that distorts competition and makes the financial system overall more risky.

According to IMF estimates, the largest, globally active banks alone benefit from implicit subsidies worth $15bn-$70bn in the US, $25bn-$110bn in Japan, $20bn-$110bn in the UK and $90bn-$300bn in the eurozone, depending on the method used to calculate them.

The fund calculated the figures by comparing the cost of insurance against default for investors in the bonds of larger and smaller banks, alongside the different credit ratings for these institutions. It estimated that the implicit subsidies have fallen since 2009, but remain sizeable.

The IMF estimates are for the year 2011-12, after most countries completed reforms such as the US Dodd-Frank act, which included measures to address too-big-to-fail.

The industry criticised a recent set of reports by the Federal Reserve Bank of New York, which also found a large too-big-to-fail subsidy, because the data it used ended in 2009. According to a New York Fed study, the biggest US banks enjoyed on average an extra $60m-$80m of cost savings per new bond sale over their smaller competitors.

“Subsidies rose across the board during the crisis but have since declined in most countries, as banks repair their balance sheets and financial reforms are put forward,” the IMF says in the report. “All in all, however, the expected probability that systemically important banks will be bailed out remains high in all regions.”

Reforms such as Dodd-Frank tried to deal with the too-big-to-fail issue by creating more plausible ways to wind up large banks without causing a crisis. However, the IMF’s results suggest they have not been completely effective.

IMF officials said the cost of the eurozone’s implicit subsidy for big banks had been exaggerated by the market turmoil in 2012. There were signs it had since fallen, said Gaston Gelos, a senior IMF analyst.

“Progress is under way but the subsidy estimates suggest the issue of too-important-to-fail is still very much alive,” Mr Gelos said.

Implicit subsidies for the largest banks were “like insurance for which banks don’t need to pay a premium”, he said. “The perception that systemically important financial institutions will be bailed-out in case of distress is declining only gradually in all regions,” he added.

Speaking in London after a meeting of the Financial Stability Board, the Basel-based body that co-ordinates financial regulators, on Monday, Mark Carney, its chair and governor of the Bank of England, said international regulators were aiming to “break the back” of the too-big-to fail issue this year by bringing forward key proposals at a G20 summit in Brisbane in November.

Mr Carney accepted that the process of addressing too-big-to-fail was taking a long time, but said this was because regulators were pushing through such detailed reforms. He added that regulators were aiming to resolve two major issues – the loss-absorbing capacity that banks have to hold and contractual provisions in derivatives contracts – by the time of the summit.

Asked about European banks’ efforts to wean themselves off the state, Mr Carney said the cumulative progress they had made was being underestimated, and praised the “comprehensive assessment” of banks’ balance sheets being undertaken by the European Central Bank.

Additional reporting by Sam Fleming in London

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