what's the problem

The roots of the TBTF problem lie in creditors' expectations. The problems arises when uninsured creditors of large, systemically important banks expect to receive government protection if their bank fails. These expectations lead banks that creditors consider too big to fail to take on too much risk and waste resources.

The underlying source of the TBTF problem is a lack of credibility. Policymakers haven't convinced uninsured creditors of TBTF banks that government will minimize the financial support they receive. Government has to figure out more effective ways to let banks know that the support is limited. Authors think that the costs of TBTF protection exceed the benefits it provides.

The reason why government want to bail out the banks is the negative externality of the bank failure. Banks face comprehensive and stringent government direction and review of their activities.

Protection of uninsured creditors of bank is one major feature that underlies any description of too big to fail. The second feature is bank size.

The price and quantity signals from creditors that previously would have constrained bank activities are muted by the expectation of TBTF protection. Every insurance policy creates a moral hazard. The excessive risk-taking by banks is costly due to resource misallocation. Excessive risk-taking also manifests itself in the provision of loans that would not be made if bank creditors bore the risk of bank failure.

The essence of the TBTF problem is that creditors believe they will receive protection on the failure of their bank despite not having an explicit right to it.