​In this revision video we look at arguments for and against bailing-out the banking system during a financial crisis.

The UK government under Chancellor Alistair Darling and Prime Minister Gordon Brown took the decision to launch a multi-billion-pound bail out of the financial system during the Global Financial Crisis which reached a peak in the Autumn of 2008 with the bankruptcy of Lehman Bros in the United States. Four major commercial banks were given a financial life-line although not every bank required one, for example Barclays (later to become mired in controversies of its own).

Royal Bank of Scotland (government acquired 84%) – still retains around 60%
Lloyds Banking Group (government acquired 43%) – all shares now sold
Northern Rock (100% nationalised) – sold to Virgin Money (2012)
Bradford and Bingley (100% nationalised – 2010, Bradford & Bingley was renamed Santander UK

Total spend on UK bank bail outs estimated at £137 billion, net spend is around £23 billion (Source: 2018 Parliamentary Research Reports)…(read more)

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Commercial bank bailouts are one of the most debated topics in recent times. It is a process of providing financial assistance to a bank by the government or a central bank to prevent it from going bankrupt. In countries where the government supports the banks, the central bank is responsible for injecting liquidity, whereas in countries where the government supports the banks, it has to provide financial relief.

In the event of a financial crisis, commercial banks struggle to operate and maintain their services. The banks, in turn, may request a bailout from the government or a central bank to prevent it from closing down. The banks are often forced to request the bailout, as the banking system is seen as a critical part of the economy. Bank failure can cause widespread economic damage, leading to a decrease in economic activity, inflation, and social unrest.

The economic rationale behind government bailouts is the concept of the ‘too-big-to-fail’ phenomenon. This theory suggests that large banks will have a significant economic impact if they fail, as they play an essential role in the financial system. A government bailout, therefore, protects the public from the unwanted economic consequences of the bank’s failure.

However, the economic impacts of commercial bank bailouts are not always positive. The consequences of providing financial assistance can cause major economic distortions. Bailing out a large bank sets a precedent for other large banks, who may also be in trouble, to expect the same treatment. This can lead to a lack of confidence in the financial sector and can lead to a decrease in aggregate demand.

Moreover, bailing out banks can lead to a moral hazard problem, where banks may take excessive risks knowing that the government is prepared to bail them out if things go wrong. The government, therefore, has to balance the needs of the economy with the long-term security of the financial sector when providing bailout support to commercial banks.

The cost of commercial bank bailouts is another significant economic factor. Governments often borrow large sums of money to finance the bailouts. This can lead to an accumulation of debt and may cause instability in the financial markets. The cost of the bailout is also borne by taxpayers, who may be unwilling to support such an action. Taxpayers may see it as unfair that their money is being used to support banks that have engaged in irresponsible lending or have taken excessive risks.

In conclusion, the economics of commercial bank bailouts are complex and can have far-reaching consequences. While they may be necessary to prevent the economy from going into recession, the moral hazard risks and costs associated with such bailouts must be carefully considered. Ultimately, the government must find a solution that balances the immediate economic threat with the long-term stability of the financial sector.