Too big to fail

During the global financial crisis, the regulators discovered the danger of having banks that are too big to fail. The collapse of a large bank would cause other financial institutions to fail, leading to a total collapse of the entire financial system. This is described as "systemic risk".

If this is so dangerous, why did the regulators allowed and encouraged the consolidation of banks in the first place? Even in Singapore, the local banks were forced to merge to become bigger banks.

If I remember the reasoning at that time, it was argued that large banks would be financially stronger and would be able to compete more effectively with other large banks to lower cost for consumers.

But this did not turn out to be the case. The consolidation of banks actually reduced competition and allowed banks to run a cartel to increase banking fees. The large investment banks, provided funds for mergers, acquisations and caused the asset bubble to grow. They made billions of dollars of profits in these "good years".

The lessons are now learnt, but rather late and at great cost to the world economy. The asset bubble grew to be so inflated that it had to find its correct level. This caused the near collapse of the financial institutions. Being "too big to fail", the banks had to be bailed out by the governments.

Going forward, what is a better approach? Smaller banks? More banks?

Tan Kin Lian