Too-Many-to-Fail and the Pricing of Risks
55 Pages Posted: 12 Feb 2016 Last revised: 2 Jul 2019
Date Written: May 19, 2019
The existence of public guarantees that are extended in the case of system-wide stress only (“too-many-to-fail”) may distort the relative pricing of risks in the financial system. Studying the market for syndicated loans, we find that banks require lower compensation for aggregate risk than for idiosyncratic risk, consistent with systemic risk-taking due to too-many-to-fail guarantees. The underpricing of aggregate risk is concentrated among banks that benefit more from increasing their exposure to these guarantees and disappears for non-bank lenders who are not covered by them. Estimates from loan-level regressions imply a sizeable guarantee that is passed onto borrowers, but also distortions in the economy’s capital allocation as lending conditions across firms change.
Keywords: Public guarantees, Too-many-to-fail, Systemic risk-taking, Loan pricing
JEL Classification: G21, G32
Suggested Citation: Suggested Citation