Paper #1328

Title:

Taming SIFIs

Authors:

Xavier Freixas and Jean-Charles Rochet

Date:

June 2012

Abstract:

We model a Systemically Important Financial Institution (SIFI) that is too big (or too interconnected) to fail. Without credible regulation and strong supervision, the shareholders of this institution might deliberately let its managers take excessive risk. We propose a solution to this problem, showing how insurance against systemic shocks can be provided without generating moral hazard. The solution involves levying a systemic tax needed to cover the costs of future crises and more importantly establishing a Systemic Risk Authority endowed with special resolution powers, including the control of bankers' compensation packages during crisis periods.

Keywords:

SIFI, dynamic moral hazard, risk taking

JEL codes:

G21; G32; G34.

Area of Research:

Finance and Accounting

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