TBTF policies seem to have played a role in the collapse of the financial systems and economies in a number of developing countries over the last decade or so.
When franchise value is high, owners and managers have something to lose, and they should take steps to make failure less likely. Franchise value depends, in part, on the level of competition in the relevant markets. Because competition in banking is often limited by regulation, banks could have an easier time generating future profits than firms in other, more competitive industries.
But now governments have relaxed some of the regulations that limited the ability of banks to enter a market and compete with established firms. New financial technologies also have raised the level of competition banks face.
Besides encouraging excessive risk-taking and wasting resources, there is a second manner in which expectation of TBTF coverage could lead to inefficiency. Recent work continues to cite this negative effect on innovation as one of the most damaging aspects of government control or influence of private sector firms.
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