Too-Many-to-Fail and the Pricing of Risks

55 Pages Posted: 12 Feb 2016 Last revised: 2 Jul 2019

See all articles by Di Gong

Di Gong

University of International Business and Economics (UIBE) - School of Banking and Finance

Wolf Wagner

Erasmus University Rotterdam (EUR) - Rotterdam School of Management (RSM); Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: May 19, 2019

Abstract

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

Gong, Di and Wagner, Wolf, Too-Many-to-Fail and the Pricing of Risks (May 19, 2019). Available at SSRN: https://ssrn.com/abstract=2730990 or http://dx.doi.org/10.2139/ssrn.2730990

Di Gong (Contact Author)

University of International Business and Economics (UIBE) - School of Banking and Finance ( email )

No.10, Huixindong Street
Chaoyang District
Beijing, 100029
China

Wolf Wagner

Erasmus University Rotterdam (EUR) - Rotterdam School of Management (RSM) ( email )

P.O. Box 1738
Room T08-21
3000 DR Rotterdam, 3000 DR
Netherlands

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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