Thus, we need to solve the “fairness/subsidy” issue, but do so in a way that ensures that the resulting regime is more stable, resilient and robust. The fairness/subsidy issue There is considerable debate about the size of the funding advantage of large banks that is due to too big to fail and how much this funding advantage creates incentives to become larger and more complex. One reason is that it is difficult to measure the size of these effects. For example, consider funding costs. We can document that larger banks’ unsecured debt funding costs tend to be lower than those for smaller banks. But the funding costs for larger firms across a broad range of industries also tend to be lower than for smaller firms in the same industries. This reflects, in part, the fact that the debt issues of larger firms tend to be more sizeable and more liquid. In addition, larger firms may be more diversified on average and thus less prone to failure, everything else equal. The measurement challenge, then, is to identify what portion of the lower funding costs at the largest financial firms, after accounting for these other factors, is due to a perception among investors that such firms are too big to fail. Despite these measurement difficulties, most of the evidence is consistent with a too big to fail funding advantage in banking.
After all, collectively these enhancements to our current regime may not solve another important problem evident within some large financial institutions – the apparent lack of respect for law,  6  BIS central bankers’ speeches  regulation and the public trust. There is evidence of deep-seated cultural and ethical failures at many large financial institutions. Whether this is due to size and complexity, bad incentives or some other issues is difficult to judge, but it is another critical problem that needs to be addressed. Tough enforcement and high penalties will certainly help focus management’s attention on this issue. But I am also hopeful that ending too big to fail and shifting the emphasis to longer-term sustainability will encourage the needed cultural shift necessary to restore public trust in the industry. One alternative strategy for dealing with too big to fail is to reduce the size of large banks by imposing size limits. While I understand the motivation, it is important to recognize that imposing size limitations might not be a very efficient means of making the financial system more stable. First, it could sacrifice some socially beneficial economies of scale and scope, especially to the global clients of large financial institutions, depending on how the size limits were implemented. Second, the resulting benefits in terms of reducing systemic risk might be quite small.