'Too-Big-To-Fail' and its Impact on Safety Net Subsidies and Systemic Risk

Abstract

The recent financial turmoil and the bailouts of some large financial institutions in the US and Europe have raised major concerns that the increased size and complexity of financial institutions may give rise to negative ramifications for systemic risk. In this paper, we investigate whether banks exploit safety net subsidies by engaging in merger and acquisition activities (M&As) and rationally increase their risk taking behaviour to the detriment of the soundness of the banking sector. Using information on bank M&As between 1997 and 2008 for a sample of nine EU economies, we find that banks pay higher merger premiums in larger M&As. Moreover, merger premiums paid in the past are positively associated with higher possibility of becoming too-big-to-fail. Finally, we find no strong evidence that M&A activities tend to be positively related to the increase of systemic risk.

Keywords: Too-big-to-fail, mergers and acquisitions, systemic risk

JEL Classification: G14, G18, G21, G34