The Knowledge Exchange / Risk Management / How big is “too big to fail?” – Part 1

How big is “too big to fail?” – Part 1

The first of a two-part debate on “too big to fail”

Tara Heuse SkinnerOccam’s Razor, the principle of selecting the most obvious or simplest solution among competing hypotheses, has some merit in the “too-big-to-fail” argument.  However, the proffered solution—interpreting Occam’s Razor as the most obvious solution—is that regulators must not only aggressively stop the ever-expanding growth of “systemically important financial institutions” (SIFIs) but also actively pursue ways to downsize SIFIs.  Many exercises designed to lesson systemic risk also increase regulatory power and, as punishment, tax those banks that contributed to the 2007 – 2009 financial crisis.

Unfortunately, this most obvious solution ignores the efforts of financial institutions to maximize value while performing necessary financial intermediation.  It also ignores the regulators’ part in creating an environment in which organizations become too big to fail.  The failure of market discipline and the failure of regulatory discipline caused the financial crisis.  This principle also discounts the effects of the risk-taking/risk-avoidance cultures of bank host countries.  The effects of culture and risk-taking are the subject of this first of two-parts on “too big to fail.”

Part 1:  The “achievement motivation” cultural dimension and risk-taking

Nearly 30 years ago, Hofstede (1983) included in his study of cultural dimensions “implications for motivation.”  By correlating two studies, he illustrated that a culture’s need for achievement corresponds to a willingness to take risks together with a desire for visible success.  The illustration below indicates ecologically derived country social systems for achievement motivation.  The countries colored in blue indicate that their social systems reward risk-taking.  Red countries are risk-avoidance cultures.  The differences in tints indicate the relativism of risk-taking — with the darkest blue being the most risk-taking and the darkest red being the most risk-avoiding.  The gray countries fall between the two extremes.

Data Source: Making Sense of Cross Cultural Communication: Geert Hofstede’s Cultural Dimensions. http://www.clearlycultural.com/geert-hofstede-cultural-dimensions/. Map created in SAS® JMP.

Note:  Cultural dimension data is not available for countries with no color.

These cultural dimensions of societal systems suggest that the threat of penalty for risk-avoidance (red) cultures would work to curtail systemic risk while rewarding appropriate risk-taking behaviors in achievement-motivated (blue) cultures.  A global solution to the too-big-to-fail problem, then, must contain both benefits for risk management and consequences for risk mismanagement or non-management.

Download both of these free white papers : The Art of Balancing Risk and Reward and Society, Shareholders and Self-Interest: Accountability of Business Leaders in the Financial Services. This research delves into the need for financial organizations to create a balance between risk management and the need to make a profit and keep their commitments to shareholders while protecting their customers.

References

Fisher, R.W., Taming the Too-Big-to-Fails:  Will Dodd-Frank be the Ticket or is Lap-Band Surgery Required? Federal Reserve Bank of Dallas, Federal Reserve Bank of Dallas Web Site:  www.dallasfed.org, 2011.

Hofstede, G., 1983. National Cultures in Four Dimensions. International Studies of Management & Organization. 13, 46-74.

Shackelford, D.A., Shaviro, D., Slemrod, J.B., 2010. Taxation and the Financial Sector. SSRN eLibrary.

Slovik, P., Systemically Important Banks and Capital Regulation Challenges. OECD Publishing, France, 2011, pp. 18.

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