Bailouts and the Modeling of Bank Distress

This study develops a model for predicting distress events among large banks. We show that a bailout possibility induces different behaviors among small and large banks, and the proposed failure prediction model for large banks is thus considerably different from that for small banks. Major bank-level fundamentals show opposite conjecture directions for large banks compared to small ones. The Tier 1 capital ratio, which is under the scrutiny of regulators and investors, has almost no distress-prediction power among large banks. However, banks rescued by governments tend to maintain a lower Tier 1 ratio. Interestingly, the cost of funding in large banks is negatively correlated with the probability of failure, reflecting lenders internalizing the too-big-to-fail (TBTF)) policy and demanding a lower interest from TBTF banks.

Keywords: Banks, Bankruptcy, Closure, Bailouts, Too-Big-to-Fail, Systemically Important Financial Institution

JEL Classification: G21, G28, G33

Suggested Citation: Suggested Citation

Galil, Koresh and Samuel, Margalit and Shapir, Offer and Wagner, Wolf, Bailouts and the Modeling of Bank Distress (October 10, 2022). Journal of Financial Research (forthcoming), Available at SSRN: https://ssrn.com/abstract=3308261 or http://dx.doi.org/10.2139/ssrn.3308261