This paper examines the relationship between banks’ observed credit default swap (CDS) spreads and possible measures of systemic importance. The authors use five-year CDS spreads from Markit with an international sample of 71 banks to investigate whether market participants are
giving them a discount on borrowing costs based on the expectation that governments would consider them ‘too big to fail’. They find a consistent, statistically significant negative relationship between five-year CDS spreads and nine different systemic importance indicators using
a generalised least squares (GLS) model. The paper finds that banks perceived as too big to fail have CDS spreads 44–80 basis points lower than other banks, depending on the asset-size threshold and controls used. Additionally, the study suggests that market participants pay more attention
to asset size than to a more complex measure, such as designation as a globally systemically important bank (G-SIB), that includes additional factors, such as substitutability and interconnectedness. Lastly, the model suggests that asset size acts as a threshold effect, rather than a continuous
effect with the best fitting models using asset-size thresholds of US$50bn–150bn.
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heightened prudential regulation;
too big to fail
Document Type: Research Article
Publication date: January 1, 2016
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Journal of Risk Management in Financial Institutions is the essential professional and research journal for all those involved in the management of risk at retail and investment banks, investment managers, broker-dealers, hedge funds, exchanges, central banks, financial regulators and depositories, as well as service providers, advisers, researchers and academics. Guided by expert Editors and an eminent Editorial Board, each quarterly 100-page issue does not publish advertising but rather in-depth articles, reviews and applied research by leading professionals and researchers in the field on six key inter-related areas: strategic and business risk, financial risk, including traditional/exotic credit, market and liquidity risks, operational risk, regulatory and legal risks, systemic risk, and sovereign risk.
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