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Discussion Paper
Did the Dodd-Frank Act End ‘Too Big to Fail’?
One goal of the Dodd-Frank Act of 2010 was to end ?too big to fail.? Toward that goal, the Act required systemically important financial institutions to submit detailed plans for an orderly resolution (?living wills?) and authorized the FDIC to create an alternative resolution procedure. In response, the FDIC has developed a ?single point of entry? (SPOE) strategy, under which healthy parent companies bear the losses of their failing subsidiaries. Since SPOE makes the parent company responsible for subsidiaries? losses, we would expect that parents have become riskier, relative to their ...
Discussion Paper
Do “Too-Big-To-Fail” Banks Take On More Risk?
In the previous post, Joo Santos showed that the largest banks benefit from a bigger discount in the bond market relative to the largest nonbank financial and nonfinancial issuers. Today?s post approaches a complementary Too-Big-to-Fail (TBTF) question?do banks take on more risk if they?re likely to receive government support? Historically, commentators have expressed concerns that TBTF status encourages banks to engage in risky behavior. However, empirical evidence to substantiate these concerns thus far has been sparse. Using new ratings from Fitch, we tackle this question by examining how ...
Journal Article
Do \\"Too-Big-to-Fail\\" banks take on more risk?
The notion that some banks are ?too big to fail? builds on the premise that governments will offer support to avoid the adverse consequences of disorderly bank failures. However, this promise of support comes at a cost: Large, complex, or interconnected banks might take on more risk if they expect future rescues. This article studies the effect of potential government support on banks? appetite for risk. Using balance-sheet data for 224 banks in forty-five countries starting in March 2007, the authors find higher levels of impaired loans after an increase in government support. To measure ...
Journal Article
Evidence from the bond market on banks’ “Too-Big-to-Fail” subsidy
Using information on bonds issued over the 1985-2009 period, this study finds that the largest banks have a funding advantage over their smaller peers. This advantage may not be entirely attributable to investors? belief that the largest banks are ?too big to fail,? because the study also finds that the largest nonbanks, as well as the largest nonfinancial corporations, have a cost advantage relative to their smaller peers. However, a comparison across the three groups reveals that the funding advantage enjoyed by the largest banks is significantly larger than that available to the largest ...
Discussion Paper
Did Subsidies to Too-Big-To-Fail Banks Increase during the COVID-19 Pandemic?
Once a bank grows beyond a certain size or becomes too complex and interconnected, investors often perceive that it is “too big to fail” (TBTF), meaning that if the bank were to become distressed, the government would likely bail it out. In a recent post, I showed that the implicit funding subsidies to systemically important banks (SIBs) declined, on average, after a set of reforms for eliminating TBTF perceptions was implemented. In this post, I discuss whether these subsidies increased again during the COVID-19 pandemic and, if so, whether the increase accrued to large firms in all ...
Discussion Paper
Fear of $10 Billion
Ten billion has become a big number in banking since the Dodd-Frank Act of 2010. When banks’ assets exceed that threshold, they face considerably heightened supervision and regulation, including exams by the Consumer Financial Protection Bureau, caps on interchange fees, and annual stress tests. There are plenty of anecdotes about banks avoiding the $10 billion threshold or waiting to cross with a big merger, but we’ve seen no systematic evidence of this avoidance behavior. We provide some supporting evidence below and then discuss the implications for size-based bank regulation—where ...
Working Paper
Are the Borrowing Costs of Large Financial Firms Unusual?
Estimates of investor expectations of government support of large financial firms are often based on large financial firms' lower borrowing costs relative to smaller financial firms. Using pricing data on credit default swaps (CDS) and corporate bonds over the period 2004 to 2013, however, we find that the CDS and bond spreads of financial firms are no more sensitive to borrower size than the spreads of non-financial firms. Outside of the financial crisis period, spreads are more sensitive to borrower size in several non-financial industries. We find that size-related differences in spreads ...