The Risk Ethics of Banks

Big Banks, Systemic Risks, and Global Financial Crises as Challenges to Modern Risk Ethics

Why This Book Matters

The 2008 global financial crisis shattered lives: millions lost work, wealth, and shelter. Governments scrambled to stop the collapse: banks were rescued, stimulus packages were launched, and corporations were propped up to prevent mass layoffs.

These interventions prevented a complete meltdown, but they left many countries – especially Greece, Spain, and Portugal – burdened with unsustainable debt. Harsh austerity policies followed, and in places like Greece people still speak of a “lost generation” of young people facing unemployment and limited opportunities.

The crisis revealed a deeper truth: some banks had grown so large and interconnected that governments felt they could not be allowed to fail. “Too big to fail” entered the public lexicon. Rescuing these institutions may have been unavoidable in the moment, but the costs were shifted onto society. This is not just an economic problem, but also an ethical one.

And the problem did not end in 2008. Fifteen years later, Credit Suisse collapsed and was taken over by UBS with state guarantees and massive central bank support—creating a bank whose assets are nearly twice the size of Switzerland’s economy. The too-big-to-fail dilemma has not been solved; it has grown. And because financial markets are global, instability in one country can quickly spread across borders, turning local crises into global shocks.

This forces us to confront deeper questions: Why are our financial systems so prone to instability? What drives the cycle of bubbles and crashes? And is it possible to design a financial system that is both resilient and just?

How Financial Fragility Builds Up

Economist Hyman Minsky spent his career exploring these questions. His Finan-cial Instability Hypothesis offers a powerful insight: stability breeds instability. When times feel calm and safe, banks and borrowers take on more risk. Risks quietly build until the system turns fragile.

Minsky identified three stages of a credit cycle:

Hedge Finance – In the cautious aftermath of a crisis, banks lend conservatively. Borrowers can repay both principal and interest from their income.
Speculative Finance – Optimism returns. Borrowers can cover interest but must roll over principal, betting on growth.
Ponzi Finance – Euphoria sets in. Borrowers cannot even meet interest payments, relying on rising asset prices—until they fall, and the system unravels.

The U.S. housing bubble followed this script: safe mortgages gave way to riskier loans and finally to “NINJA loans” (No Income, No Job, No Assets). When interest rates rose and house prices fell, defaults cascaded and the financial system nearly collapsed.

How Too Big to Fail Fuels the Fragility Minsky Warned Of

The 2008 crash unfolded much as Minsky predicted—and too-big-to-fail banks made it worse: After the dotcom crash, low interest rates and mortgage securitization fueled a new credit boom. At first lending was cautious, but soon Lehman became one of the most aggressive players in subprime mortgages and securitization. By the mid-2000s, it was speculating directly on real estate while relying heavily on short-term funding.

When housing prices turned, Lehman’s losses spiraled. Liquidity evaporated, confidence collapsed, and on September 15, 2008, it filed for bankruptcy—the largest in U.S. history. Lehman was the exception: it was allowed to fail. Most large institutions—banks like Citigroup as well as insurers like AIG—were rescued.

This inconsistency was crucial. Lehman’s bankruptcy did not disprove too big to fail; it revealed that rescue policy was unpredictable. Markets could not know in advance which institutions would be saved and which abandoned. That uncertainty magnified panic and showed why too-big-to-fail banks amplify fragility.

In the hedge phase, their size floods the system with credit, even in cautious times.
In the speculative phase, the expectation of rescue encourages leverage and risk-taking.
In the Ponzi phase, their balance sheets make crises unmanageable, forcing governments to privatize gains and socialize losses.

The lesson is clear: when collapse threatens the system, the state intervenes. This creates moral hazard: if bankers expect rescue, they have every reason to gamble. As former Citigroup CEO Chuck Prince put it in July 2007: “As long as the music is playing, you’ve got to get up and dance.” And when the music stopped, it was citizens—not bankers—who paid the price.

This is more than a technical flaw in financial regulation. It is a question of justice. If ordinary people bear the costs of risks they never chose, then the design of money and credit is not just an economic issue—it is an ethical one. Without deeper reform, the cycle will repeat.

The Ethical Dimension

Philosopher Alan Gewirth argued that all people have basic rights—life, food, shelter, property—that must not be arbitrarily endangered. Yet too big to fail exposes millions of people worldwide to risks they never chose.

In my work, I argue that for an institutional risk to be ethically acceptable, it should meet at least two of three conditions:

Functional: The risk must support a context of action that protects rights sustainably (e.g., by fostering stable growth).
Distributive: The costs must be fairly shared, not dumped on the weakest.
Procedural: Those affected should have a voice in accepting or rejecting the risks.

Too big to fail fails on all three subcategories. Research shows that very large banks do not improve growth and often harm it by channeling credit into speculation rather than productive investment. The costs of crises fall hardest on the poor, the unemployed, and the unprotected. And no one ever consented to bearing these risks. True consent would mean democratic accountability in financial governance—citizens having a voice in how money and credit are created.

From this perspective, too big to fail is not only economically dangerous but also ethically indefensible.

Can We Fix It?

After 2008, regulators promised change. New rules (Basel III), resolution tools (EU’s Single Resolution Mechanism), and stronger supervision were introduced. Yet core vulnerabilities remain:

Capital requirements are still far too low.
Resolution mechanisms have failed in practice.
Supervisory authorities can face goal conflicts.

Real reform needs three principles:

Reduce fragility, rather than pretend crises can be predicted.
Ensure liability, so those who take risks bear the costs (“skin in the game”).
Simplify rules, so they are transparent and harder to game.

As Anat Admati and Martin Hellwig emphasize in The Bankers’ New Clothes (2013), meaningful reform requires raising equity requirements to 20–30% for all banks—not only the largest. In addition, I argue that surcharges on too-big-to-fail institutions would curb hidden subsidies and create incentives for them to shrink.

But stronger buffers are not enough. We must also confront a deeper question: how money and credit are created.

Banks do not merely lend out deposits. They create new money whenever they issue credit. Where that credit flows shapes the economy. Productive credit supports factories, technology, and infrastructure. But much of today’s credit flows into existing assets—especially real estate.

According to Adair Turner, the key source of financial instability is bank credit driving bidding wars among citizens over scarce urban land. When bank credit floods property markets, it fuels a self-reinforcing spiral of rising prices, more borrowing, and greater fragility. This cycle—credit chasing land—has been behind many crises throughout history.

Because the money-and-credit machine is so powerful, stricter bank rules alone will not suffice. We must rethink how money and credit are created and governed. I therefore propose an EU-level public inquiry—an enquête commission—into the future of money and credit, tasked with systematically examining reforms such as the Chicago Plan (full-reserve deposits to curb bank runs and credit cycles), sovereign money (a central bank monopoly on money creation), narrow banking, and related ideas. Its work should be guided by four plain questions:

How can we best tame boom-bust credit cycles?
How do we ensure true “skin in the game,” so risk-takers bear losses?
Which system is simplest to run and hardest to game?
How do we balance market freedom with fair protection?

The commission must be independent, interdisciplinary, and inclusive—combining expertise with citizen voices. It should be humble about unknowns but not paralysed by them.

Conclusion

Too-big-to-fail banks magnify financial cycles, privatize profits, and socialize losses. They fail the risk ethical tests of function, fairness, and consent. And despite years of reform, they are bigger and riskier today than before 2008.

The lesson of the last crises—from Lehman to Credit Suisse—is clear: too big to fail is not history. It is the unresolved risk of our present.

The path forward has two essentials:

Raise equity requirements and create incentives for banks to shrink.
Launch a public inquiry into the creation of money and credit, weighing systemic reforms.

As Minsky and Turner remind us, when bank credit fuels speculation on scarce land, instability follows—and millions pay the price.

We cannot wait for the next crash. The choice is stark: confront too big to fail and reform credit creation, or continue in a system where fragility is built in and its costs fall on those least able to bear them. Real reform is possible. More than that, it is a moral duty—if we want economies that protect the vulnerable and provide opportunity for every citizen.

Who Should Read This Book?

Citizens who want to understand the risks too-big-to-fail banks pose to their savings and livelihoods.
Ethicists exploring how moral theory applies to modern finance.
Economists examining why credit creation and systemic fragility were ignored for so long.
Regulators searching for tools to make the system safer.
Policymakers seeking ways to finally confront the too-big-to-fail problem.

Praise & Reception

In 2020, Risk Ethics of Banks was nominated for the German Study Award of the Körber Foundation, one of Germany’s most prestigious research prizes for dissertations. Out of 489 submissions, the jury selected 31 doctoral graduates as finalists across three categories; in the field of Humanities and Cultural Studies (Geistes- und Kulturwissenschaften), I was among the ten finalists.

“...a book of fundamental importance. Sohrabi offers a detailed account of the risks still posed by large banks — the so-called 'too big to fail' institutions. [...] Ultimately, the author’s achievement lies in his concise analysis of the financial system and the role of major banks within it. At the same time, Sohrabi presents precise proposals for how future crises might be prevented. [...] A clear recommendation to read. Even highly complex matters are explained in clear language, and their implications are derived with rigor — it’s masterful.”

— Marco Wehr, Das Philosophische Labor, Tübingen

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Book Details

Author: Dr. Vandad Sohrabi
Publisher: Mohr Siebeck (Perspektiven der Ethik, Vol. 15)
Publication Date: 2020
Pages: 410
Formats: Paperback, eBook (PDF)
License: CC BY‑NC‑ND 4.0 (Open Access)
ISBN: 978‑3‑16‑159197‑6