Are the Borrowing Costs of Large Financial Firms Unusual?

Abstract

Government guarantees are often offered as an explanation for why large financial firms borrow more cheaply than small financial firms. However large firms generally borrow more cheaply across a wide range of non-financial industries. We show that the difference in borrowing costs between large and small financial firms is not unusual compared to other industries. These size-related differences are present after controlling for default risk and are only partially explained by higher liquidity and recovery rates for larger borrowers. Our results suggest that estimates of implicit government guarantees based on size-related borrowing cost differentials for financial firms may be overstated. However our analysis also finds that in the period leading up to the 2008-9 financial crisis, borrowing costs were lower for the financial industry as a whole. This result is consistent with an implicit government guarantee, or generally reduced investor risk perceptions, lowering borrowing costs for the entire financial industry rather than specifically for the largest financial institutions.

Keywords: Financial industry, too-big-to-fail, implicit government guarantee, size effect, borrowing costs, credit default swaps

JEL Classification: G21, G22, G24, G28