Are banks still too-big-to fail?

In this paper, we use Fitch’s new support rating floor to investigate whether markets still perceive some banks to be too big to fail. An important feature of this rating is that it captures only the likelihood that the government will support the bank. Our results show that banks enjoy an abnormal decline in their CDS spreads when Fitch announces an increase in the likelihood of government support. These effects are larger for riskier banks and for announcements of larger increases in the likelihood of government support. More importantly, these effects persist when we restrict our investigation to Fitch announcement of an increase in the support rating floor of the bank while maintaining its financial strength rating unchanged. We unveil these finds based on a global sample of banks, but for the most part they continue to hold when we restrict our analysis to US banks only. Our findings indicate that Fitch’s new support rating does carry information and that markets still perceive some banks to be too big to fail despite all of the regulatory changes already implemented targeting this problem.

“This paper is part of the mini conference on "The Future of Large Financial Institutions" at the 2014 fall meetings of the International Atlantic Economic Society.  Sessions on this and related themes are expected to be continued at the spring 2015 meetings in Milan and the fall 2015 meetings in Boston.”