Final answer:
The problem of 'too big to fail' can be avoided through strict regulation, breaking up large banks, and enhancing competition in the banking industry.
Step-by-step explanation:
The problem of 'too big to fail' refers to the idea that some banks are so large and interconnected that their failure could have catastrophic effects on the economy, leading to a government bailout to prevent further damage. This can create moral hazard, as these banks may take excessive risks knowing that they will be bailed out if they fail. There are several ways to avoid the problem of 'too big to fail':
- Strict regulation: Implementing stricter regulations and oversight on large financial institutions to prevent excessive risk-taking and ensure their stability.
- Breaking up large banks: Breaking up large banks into smaller, more manageable entities to reduce their systemic risk and avoid the 'too big to fail' problem.
- Enhancing competition: Encouraging competition in the banking industry to reduce the concentration of power among a few large banks, which can help mitigate the 'too big to fail' issue.