Why Banks are Not Too Big to Fail: Evidence from the CDS Market

35 Pages Posted: 13 Apr 2013

See all articles by Andreas Barth

Andreas Barth

Goethe University Frankfurt - Department of Finance

Isabel Schnabel

University of Bonn - Institute for Financial Economics and Statistics; Max Planck Society for the Advancement of the Sciences - Max Planck Institute for Research on Collective Goods

Date Written: April 2013

Abstract

This paper argues that bank size is not a satisfactory measure of systemic risk because it neglects aspects such as interconnectedness, correlation, and the economic context. In order to differentiate the effect of bank size from that of systemic importance, we control for systemic risk using the CoVaR measure introduced by Adrian and Brunnermeier (2011). We show that a bank's contribution to systemic risk has a significant negative effect on banks’ credit default swap (CDS) spreads, supporting the too‐systemic‐to‐fail hypothesis. Once we control for systemic risk, bank size (relative to gross domestic product (GDP)) has either no or a positive effect on banks’ CDS spreads. The effect of bank size increases in the home country's debt ratio and turns positive already at moderate debt ratios. This result is consistent with the too‐big‐to‐save hypothesis. We show further that the effect of systemic risk rises sharply at the onset of the financial crisis in August 2007, but weakens after the failure of Lehman Brothers, reflecting changing bailout expectations. Taken together, our results suggest that banks are not too big to fail, but they may be too systemic to fail and too big to save.

Suggested Citation

Barth, Andreas and Schnabel, Isabel, Why Banks are Not Too Big to Fail: Evidence from the CDS Market (April 2013). Economic Policy, Vol. 28, Issue 74, pp. 335-369, 2013. Available at SSRN: https://ssrn.com/abstract=2250230 or http://dx.doi.org/10.1111/1468-0327.12007

Andreas Barth

Goethe University Frankfurt - Department of Finance ( email )

Theodor-W.-Adorno-Platz 3
Frankfurt, 60629
Germany

Isabel Schnabel

University of Bonn - Institute for Financial Economics and Statistics ( email )

Adenauerallee 24-42
Bonn, 53113
Germany

HOME PAGE: http://www.finance.uni-bonn.de/schnabel

Max Planck Society for the Advancement of the Sciences - Max Planck Institute for Research on Collective Goods ( email )

Kurt-Schumacher-Str. 10
D-53113 Bonn, 53113
Germany
+49-228-9141665 (Phone)
+49-228-9141621 (Fax)

HOME PAGE: http://www.coll.mpg.de/team/page/isabel_schnabel

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