Which Countries Are Prepared to Handle Another Financial Crisis?
Paul Tucker, the deputy governor of the Bank of England, said recently that the European Union has lagged behind the United States in establishing a situation whereby future bank failures could be mitigated, Reuters reports.
After the failure of banks like Lehman Brothers nearly five years ago, which some had dubbed “too big to fail,” many were concerned that bailouts would only serve to immediately remedy the situation but would not fix the underlying problem. In fact, bailouts could even worsen the situation by sending the message that governments are willing to provide safety nets for banks that took, in essence, too many risks.
When banks choose asset portfolios, there is usually a tradeoff between risk and reward; thus, assets with higher expected returns can be taken on at the cost of additional risk. Many companies choose not to do this because the risk of failure is a serious concern for both management and shareholders. However, if a government were to step in with funds to rescue a failed bank, this problem is removed, essentially rewarding poor decision making that was overly risky.