When Enough Is Not Enough: Bank Capital and the Too-Big-To-Fail Subsidy
64 Pages Posted: 15 Jun 2017 Last revised: 19 Jun 2019
Date Written: January 31, 2019
This paper takes a unique approach to study the relationship between bank capital and Too-Big-To-Fail (TBTF) during the Financial Crisis. A structural credit risk model is used to compute implied market value capital ratios which, when compared to traditional risk-based capital, illustrates the capital deficiency of large BHCs. As these BHCs' implied capital deteriorated, their default probabilities spiked. The model is then used to solve for the amount of capital needed to reduce default probabilities. This amount is compared to the TARP capital infusions to quantify the TBTF subsidy which is associated with size and reliance on short-term volatile funding.
Keywords: Bank Capital, Too-Big-To-Fail, TARP, Structural Credit Risk Model, Bank Default Probability
JEL Classification: G01, G21, G28, G32
Suggested Citation: Suggested Citation