What are the three approaches to limiting the too-big to- fail problem? Briefly describe the advantages and disadvantages of each of the approaches.

Generally, when big companies fail, their failure will cripple the whole economy. This is the so-called too-big-to-fail problem. Major corporations, particularly financial institutions, are so large and interconnected that if they are to fail, the whole economy will collapse.

Break up Large, Systematically Important Financial Institutions approach:

In the event that a financial institution fails, after a sufficient time, there will be no need to bail it out. This is the first approach to avoiding the problem of two-big-to-fail.

The largest financial institutions have opposed both of these approaches. One of them would be to reimpose the restrictions that existed before the G-S was annulled, while the other would be to specify a maximum limit over which no institution could have assets.

A company can be broken up to eliminate the 'Too-Big-to-Fail' problem if there are synergies available that might provide the largest companies with better risk management capabilities or lower costs. It is possible that breaking up the financial system would actually detract from its efficiency rather than boost it.

Higher Capital Requirements approach:

Another method is to require the largest institutions to maintain higher capital ratios. The larger capital of these institutions will allow them to not only withstand losses if they happen, but also give them more to lose and give them a larger stake in the game.

By increasing capital requirements, too-big-to-fail institutions lose their subsidy for risk-taking. Due to heightened risk-taking during boom times, capital requirements could also increase during periods of rapid credit expansion, while they would decrease during periods of credit contraction.

Capital requirements under these measures could become more countercyclical, thereby reducing the boom-bust cycle.

Leave it to the Dodd-Frankapproach:

Three ways in which the D-F can alienate the too-big-to-fail problem include increasing regulations on financial institutions, as well as implementing the Volcker rule, which will make it more difficult for the Fed to intervene in the financial system.

However, there is doubt that this bill will ultimately eliminate the too-big-to-fail problem.