Safety-Net Benefits Conferred on Difficult-to-Fail-and-Unwind Banks in the US and EU Before and During the Great Recession
44 Pages Posted: 29 Jan 2011 Last revised: 16 Aug 2011
Date Written: August 15, 2011
This paper investigates the links between regulatory arbitrage, financial instability, and taxpayer loss exposures. We model and estimate ex ante safety-net benefits from increased leverage and asset volatility at a sample of large banks in US and Europe during 2003-2008. Hypothesis tests indicate that, in both crisis and precrisis years, difficult-to-fail-and-unwind (DFU) banks enjoyed substantially higher ex ante benefits than other institutions. Compared to the US sample, safety-net benefits prove significantly larger for DFU firms in Europe and bailout decisions are less driven by asset size. Introducing a proxy for differences in government susceptibility to regulatory capture helps to explain bailout decisions in Europe. Our findings suggest that authorities in both venues could better contain safety-net benefits if they refocused their information systems on monitoring volatility as well as capital.
Keywords: financial safety net, too big to fail, financial crisis, financial subsidies,regulatory arbitrage
JEL Classification: G21,G01
Suggested Citation: Suggested Citation