During the financial crisis of 2007-2009 it became painfully clear that the regulation and monitoring of banks’ risks were still imperfect. In hindsight, academics agree that regulators were too focused on banks’ individual risks while lacking when it came to systemic risk. Systemic risk can be thought of as the probability that an occurrence at one company causes instability or the collapse of other companies or even an entire industry. The event that triggered the recent financial crisis was the bursting of the U.S. housing bubble, which affected many financial institutions through its negative impact on mortgage-backed securities and commercial paper markets (Mian & Sufi, 2009). The following spread of this crisis throughout the world revealed just how intertwined and …show more content…
Such firms are considered as ͞too big to fail͟ and need government bailouts to prevent further damage to the real economy. For instance, the crisis in 2008 led to the bailout of the insurance company AIG with US government loans of over $180 billion as well as to necessary rescues of Merrill Lynch, Citigroup, Bank of America, Morgan Stanley, Goldman Sachs and many others. The fact that taxpayers’ money had to be used for the bailouts of these so called global systemically important financial institutions (G-SIFIs), sparked the public’s interest in financial regulation. The consequences discussed above lay bare the underlying assessment from which statutory regulation and supervision draw their legitimacy: the negative external effects of certain actions are not taken into account in a bank’s private decision making (Hellwig, 2010). While the problem of negative externalities not being internalized is a common problem in economics, it deserves extra attention in the case of the financial