When enough is not enough: bank capital and the Too-Big-To-Fail subsidy

This paper takes a unique approach to study the relationship between bank capital and Too-Big-To-Fail (TBTF) during the Financial Crisis. A structural credit risk model is used to compute implied market value capital ratios which, when compared to traditional risk-based capital, illustrates the capi...

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Bibliographic Details
Published in:Review of quantitative finance and accounting 2020-11, Vol.55 (4), p.1371-1406
Main Author: Imerman, Michael B.
Format: Article
Language:English
Subjects:
Accounting/Auditing
Corporate Finance
Econometrics
Economics and Finance
Finance
Operations Research/Decision Theory
Original Research
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Summary:This paper takes a unique approach to study the relationship between bank capital and Too-Big-To-Fail (TBTF) during the Financial Crisis. A structural credit risk model is used to compute implied market value capital ratios which, when compared to traditional risk-based capital, illustrates the capital deficiency of large BHCs. As these BHCs’ implied capital deteriorated, their default probabilities spiked. The model is then used to solve for the amount of capital needed to reduce default probabilities. This amount is compared to the TARP capital infusions to quantify the TBTF subsidy which is associated with size and reliance on short-term volatile funding.
ISSN:0924-865X
1573-7179
DOI:10.1007/s11156-020-00877-x