Nevertheless, as Martin Hellwig and Anat Admati point out in their book “The Bankers’ New Clothes”: “The question of whether banks should be allowed to fail rarely arises as a matter of principle.” Thus one would argue that, from a policymaker’s perspective, it may be better to forget about principles and to do what needs to be done to prevent immediate damage.
However, beyond the necessities of the moment, letting banks fail might have positive effects. If the threat of failure is credible, then it may encourage banks to behave prudently. The financial system is likely to become smaller and better capitalised.