Are Banks still ’Too Big to Fail’? – A market perspective

Mostly Economics

Nicole Allenspach, Oleg Reichmann and Javier Rodriguez-Martin in this Swiss National Bank paper:

This paper aims at deriving the market’s assessment as to whether banks worldwide still benefit from a Too Big To Fail (TBTF) subsidy. Such a subsidy reflects the market’s expectation of government support in the event of a crisis and results in reduced funding costs
for the benefiting bank. To capture this effect, we use two different extensions of the Merton (1974) framework. We find that large banks
benefit from a TBTF subsidy, while large nonfinancial firms do not. This subsidy has declined somewhat since the Global Financial Crisis
(GFC) but remains larger than before the crisis. These conclusions also hold when considering Contingent Convertible (CoCos) and bailin bonds as fully loss-absorbing. Moreover, we find differences in the TBTF subsidy across jurisdictions and provide evidence that these can to a large extent be explained by differences…

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