Are banks too big to fail or too big to save? International evidence from equity prices and CDS spreads

A. Demirgüc-Kunt, H.P. Huizinga

Research output: Contribution to journalArticleScientificpeer-review

Abstract

Deteriorating public finances around the world raise doubts about countries’ abilities to bail out their largest banks. For an international sample of banks, this paper investigates the impact of bank size and government deficits on bank stock prices and CDS spreads. We find that a bank’s market-to-book value is negatively related to the size of its liabilities-to-GDP ratio, especially in countries running large public deficits. CDS spreads appear to decrease with stronger public finances. These results suggest that systemically important banks can increase their value by downsizing or splitting up, especially if they are located in countries with weak public finances. We document that banks’ average liabilities-to-GDP ratio reached a peak in 2007 before a significant drop in 2008, which could reflect these private incentives to downsize.

Highlights
► Bank market value negatively reflects bank size relative to GDP. ► This effect is stronger in countries that run large deficits. ► This evidence suggests that banks can be too large to save.
Original languageEnglish
Pages (from-to)875-894
JournalJournal of Banking and Finance
Volume37
Issue number3
Publication statusPublished - 2013

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Too big to fail
Equity prices
Credit default swap (CDS) spreads
Public finance
Liability
Bank size
Market value
Bailout
Government deficits
Downsizing
Stock prices
Incentives
Public deficit
Book value

Cite this

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abstract = "Deteriorating public finances around the world raise doubts about countries’ abilities to bail out their largest banks. For an international sample of banks, this paper investigates the impact of bank size and government deficits on bank stock prices and CDS spreads. We find that a bank’s market-to-book value is negatively related to the size of its liabilities-to-GDP ratio, especially in countries running large public deficits. CDS spreads appear to decrease with stronger public finances. These results suggest that systemically important banks can increase their value by downsizing or splitting up, especially if they are located in countries with weak public finances. We document that banks’ average liabilities-to-GDP ratio reached a peak in 2007 before a significant drop in 2008, which could reflect these private incentives to downsize.Highlights► Bank market value negatively reflects bank size relative to GDP. ► This effect is stronger in countries that run large deficits. ► This evidence suggests that banks can be too large to save.",
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Are banks too big to fail or too big to save? International evidence from equity prices and CDS spreads. / Demirgüc-Kunt, A.; Huizinga, H.P.

In: Journal of Banking and Finance, Vol. 37, No. 3, 2013, p. 875-894.

Research output: Contribution to journalArticleScientificpeer-review

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AB - Deteriorating public finances around the world raise doubts about countries’ abilities to bail out their largest banks. For an international sample of banks, this paper investigates the impact of bank size and government deficits on bank stock prices and CDS spreads. We find that a bank’s market-to-book value is negatively related to the size of its liabilities-to-GDP ratio, especially in countries running large public deficits. CDS spreads appear to decrease with stronger public finances. These results suggest that systemically important banks can increase their value by downsizing or splitting up, especially if they are located in countries with weak public finances. We document that banks’ average liabilities-to-GDP ratio reached a peak in 2007 before a significant drop in 2008, which could reflect these private incentives to downsize.Highlights► Bank market value negatively reflects bank size relative to GDP. ► This effect is stronger in countries that run large deficits. ► This evidence suggests that banks can be too large to save.

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