Big Banks Benefit From Government Subsidies

Banks deemed ‘too important to fail’ borrow at lower rates, take bigger risks

Policymakers should aim to remove this advantage to protect taxpayers, ensure level playing field, promote financial stability

Reforms helped reduce the implicit public subsidy to big banks

In its latest analysis for the Global Financial Stability Report, the IMF shows that big banks still benefit from implicit public subsidies created by the expectation that the government will support them if they are in financial trouble. In 2012, the implicit subsidy given to global systemically important banks represented up to $70 billion in the United States, and up to $300 billion in the euro area, depending on the estimates.

Government support to banks during the crisis has taken different forms, from loan guarantees to direct injection of public funds into banks. The expectation of that support allows banks to borrow at cheaper rates than they would if the possibility of that support didn’t exist. Those lower funding costs represent an implicit public subsidy to large banks.

Subsidy encourages risk-taking

This implicit subsidy distorts competition among banks, can favor excessive risk-taking, and may ultimately entail large costs for taxpayers. While policymakers may need to rescue big banks in distress to safeguard financial stability, such rescues are costly to governments and taxpayers. Moreover, the expectation of government support reduces the incentives of creditors to monitor the behavior of big banks, thereby encouraging excessive leverage and risk-taking.

Recent financial reforms and progress in banks’ balance sheet repair have contained the too-important-to-fail issue, albeit with unequal results across countries. The analysis found that particularly large subsidies persist in the euro area, and to a smaller extent in Japan and the United Kingdom.

“Progress is under way, but the subsidy estimates suggest the issue of too-important-to-fail is still very much alive,” said Gaston Gelos, chief of the Global Stability Analysis Division in the IMF’s Monetary and Capital Markets Department that produced the report.

Banks grew bigger

The IMF said the issue of too-important-to-fail has intensified in the wake of the financial crisis for two main reasons:

• The turmoil that followed the failure of Lehman Brothers in September 2008 forced governments to intervene massively to maintain confidence in the banking sector, and prevent a collapse of the whole financial...