THE PRIVATE VALUE OF

TOO-BIG-TO-FAIL
(TBTF)
ARTICLE WRITTEN BY: MICHIEL J. BIJLSMA, AND REMCO J.M.
MOCKING

By:
- Jack Meijer
- Hidde Koopman
- Thijs Mannaerts
 • WHAT ARE TBTF BANKS?
• OVERVIEW OF THE EMPIRICAL
LITERATURE AND MEASUREMENT OF TBTF
SUBSIDY
CONTEN • METHODOLOGY AND DESCRIPTION OF
T DATA
• RESULTS AND CONCLUSION
• WEAK AND STRONG POINTS
• DISCUSSION
 TOO-BIG-TO-FAIL

BANKS THAT HAVE VERY LARGE BANKS, CATASTROPHIC

BECOME TOO SO MANY ECONOMIC
IMPORTANT TO THE INSTITUTIONS REPERCUSSIONS
FINANCIAL SYSTEM. RELYING ON THEM WHEN GOING
BANKRUPT
 GOVERNMENT BAIL-OUT LEADS TO

Lower funding
Too cheap
cost, Higer risk
financial
competitive taking
services
advantage
 LITERATURE

•5 EMPIRICAL STRATEGIES:
• EVENT STUDIES
• MARKET PRICES DISTORTIONS
• ISSUER RATINGS
• CONTINGENTS CLAIM MODEL
 EVENT STUDIES
• ESTIMATE IMPACT OF EVENTS
• PROVE EXISTENCE OF TBTF BANKS, BY CHANGE
IN MARKET BELIEFS
 MERGERS AND ACQUISITIONS

•INCENTIVES FOR BANKS TO BECOME TBTF:

• BANKS EARN PREMIUM, INCREASE IN STOCK MARKET VALUE
• HIGHER BOND RETURNS
• DECREASE IN CREDIT SPREAD

•BECAUSE OF THESE BENEFITS BANKS ARE WILLING TO PAY HIGHER

PREMIUMS TO BECOME TBTF
 DISTORTION OF MARKET PRICE

• BIGGER SIZE IS LOWER CREDIT DEFAULTS SWAP SPREADS.

• LESS DEFAULT LEADS TO REDUCTION OF CDS SPREADS.
• LESS DEFAULT LEADS TO HIGHER STOCK-TO-MARKET CDS PRICES
COMPARED TO MARKET PRICES
• PRICE DIFFERENCES POSITIVELY RELATED TO SIZE
 TOO BIG TO RESCUE

• GOVERNMENT CANNOT BAILOUT BANK BECAUSE THEY DO

NOT HAVE THE CAPACITIES
• BANK IS TOO BIG
• WHEN MARKET CAPITALIZATION IS BEYOND 10% OF GDP
BAILOUT IS LESS LIKELY
 ISSUER RATINGS

Relation bond
Opinions about spreads and issuer
TBTF bond less TBTF banks more
banks ratings relatively
sensitive to ratings stable so less risky
creditworthiness. flat for TBTF
banks.
 CONTINGENT CLAIMS

Expected
Value subsidy
annual subsidy
equal to value
payment
payoff
government
METHODOLOGY
 FUNDING ADVANTAGE

Funding advantage
Credit ratings with(out) explicit and implicit external
support
Other definition

Relationship bond yields and LTD rating

 REGRESSION
•BOND YIELDS AND LTD RATING

•TAKING AWAY UNCERTAINTY

•IDENTIFY AMOUNT OF DEBT FUNDING ->

• ISSUED DEBT OR TOTAL WHOLESALE FUNDING

•ONLY LONG TERM-DEBT -> MATURITY

 CAVEATS
• DISTINGUISH ECONOMIES OF
SCALE

• RATING METHODOLOGY

• DATA LIMITATIONS
 LTD measure (long term
deposit)
Ability to repay
DATA
RATINGS BFS (banks financial strength)

Systemic risk
 BOND YIELDS

•BOND WITH AAA, AA3,

BAA1 AND BAA RATINGS
•RATINGS AND YIELD
• COEFFICIENT SIGNIFICANT -> 1.96
5. RESULTS
RESULTS

● FUNDING COST ADVANTAGE APPROACH

● INFLUENCED BY:
•RATING UPLIFT
•YIELD REDUCTION
•AMOUNT OF DEBT.
RESULTS

•RATING UPLIFT
RESULTS

•YIELD REDUCTION
RESULTS
•AMOUNT OF DEBT (LONG TERM DEBT, LTD)
RESULTS

•COMBINE THE 3 FACTORS

RESULTS

•CREDIBILITY OF COUNTRY
RESULTS

•HIGH BFS -> LOW FUNDING ADVANTAGE

•HIGH SOVEREIGN RATING -> HIGH FUNDING
ADVANTAGE
RESULTS

● REGRESSION
○ WHY DO BANKS GET A HIGHER RATING UPLIFT THAN OTHERS?

● WHERE, RUIT = AVERAGE RATING UPLIFT OF BANK (I) IN YEAR (T)

○ BFS RATING CONSTRAINT

● XIT = COUNTRY SPECIFIC VARIABLES

RESULTS

● OLS RESULTS
● MULTIPLE SPECIFICATIONS
RESULTS
•SPECIFICATION 1 & 2

•DUMMY VARIABLE TBTF

•BOTH STATISTICALLY SIGNIFICANT

AND POSITIVE IMPACT ON RUIT

•RELATIVE RUIT TBTF BANKS 13% HIGHER THAN SMALL BANKS

RESULTS
•SPECIFICATION 3 & 4

•SR VARIABLE (SOVEREIGN RATING)

•SR HAS POSITIVE AND SIGNIFICANT

INFLUENCE ON RUIT

•BANKS IN HIGH SR COUNTRIES ENJOY POSITIVE RATING

UPLIFT
RESULTS
•SPECIFICATION 5 & 6

•MULTIPLE TBTF THRESHHOLDS

•LARGEST POSITIVE EFFECT FOR BANKS

WITH ASSETS > $1000B ($1 TRILLION)

•AGAIN, BANKS IN HIGH SR COUNTRIES ENJOY POSITIVE

RATING UPLIFT
STRENGTHS & WEAKNESSES OF
PAPER

Strengths: Weaknesses:
• Detailed and • Narrow Scope
Precise • Biased Outcome
• Explicitatory
 Explanation of Funding
Advantage

STRENGT
HS OF Use of different Theories,
Perspectives and Views
PAPER
Regression model: adequate
use of variables
 Relevance of Financial
Regulations not Covered
WEAKNESS
ES OF Conflicting Hypothesis
PAPER

Biased Outcome
 Similarities
: Moral Hazard & Too Big To
Fail

PAPER VS Different Possible Effects of

M&A on Creditworthiness
MISHKIN Differences
THEORY : Financial Regulations
6. CONCLUSION
 •Large size and fluctuations of
funding advantage

CONCLUSIO •Higher funding advantage results

N in a rating uplift and yield reduction

•High sovereign ratings have

positive effects on the rating uplifts
DISCUSSION