Are Banks Too Big to Fail or Too Big to Save?

First, in Table 7, we present results of regressions where the market-to-book ratio and the CDS spread are related to bank and banking-system size and bank risk variables and a host of control variables. Specifically, Panel A presents regressions where the market-to-book ratio and the CDS spread are related only to the bank and banking-system size and risk variables, while Panel B presents regressions that in addition include the control variables. The market-to book ratio is the dependent variable in regressions 1-5 in either panel, while the CDS spread is the dependent variable in regressions 6 through 10. All regressions include country and year fixed effects, and errors are clustered at the level of the bank.  

Table 7. Determinants of the market-to-book ratio and the CDS spread 

The dependent variable is the market-to-book ratio in columns 1 to 5 and the CDS spread in columns 6 to 10 in both Panel A and Panel B. Market-to-book is the market value of common equity divided by the book value of common equity. CDS is the annual average of daily credit default spreads on a 5-year contract. Assets is natural logarithm of  total assets in constant 2000 US dollars. Pre-tax profits is pre-tax profits divided by total assets. Earning assets is earning assets divided by total assets. Leverage is liabilities divided by total assets. GDP per capita is GDP per capita in constant 2000 dollars. Past crisis is dummy variable that is one if country is not currently experiencing a banking  crisis but has experienced a banking crisis before and zero otherwise. Past fiscal cost is fiscal cost of resolving most recent but not current banking crisis divided by GDP. Public debt is central government debt divided by GDP. Bank stock risk is annualized standard deviation of weekly dividend-inclusive bank stock returns. Liabilities is bank  liabilities divided by GDP. Sum liabilities is sum of bank liabilities in a country divided by GDP. Other liabilities is sum of the liabilities of other banks in a country divided by GDP. Liabilities sq is square of ratio of bank liabilities to GDP. All regressions are estimated with year and country fixed effects and clustering at the bank level. Standard  errors are in parentheses. *, ** and *** denote significance at 10%, 5% and 1% respectively. 

Panel A: Basic regressions 

	Market-to-Book	Market-to-Book	Market-to-Book	Market-to-Book	Market-to-Book	CDS	CDS	CDS	CDS	CDS
	(1)	(2)	(3)	(4)	(5)	(6)	(7)	(8)	(9)	(10)
Assets	0.071***	0.069***	0.070***	0.078***	0.078***	-0.000	-0.000	-0.000	-0.000	-0.000
	(0.010)	(0.009)	(0.010)	(0.010)	(0.010)	(0.000)	(0.000)	(0.000)	(0.000)	(0.000)
Public debt	-0.770***	-0.763***	-0.764***	-0.786***	-0.781***	-0.018	-0.019	-0.019	-0.017	-0.017
	(0.105)	(0.105)	(0.105)	(0.105)	(0.105)	(0.011)	(0.011)	(0.011)	(0.011)	(0.011)
Bank stock risk	0.127*	0.125*	0.126*	0.128*	0.128*	0.029***	0.029***	0.029***	0.029***	0.029**
	(0.066)	(0.066)	(0.066)	(0.066)	(0.066)	(0.011)	(0.011)	(0.011)	(0.011)	(0.011)
Liabilities	-0.035		-0.021	-0.570***	-0.555***	0.000		0.000	-0.004	-0.004
	(0.130)		(0.133)	(0.171)	(0.172)	(0.002)		(0.002)	(0.005)	(0.005)
Sum liabilities		0.020					0.000
		(0.027)					(0.001)
Other liabilities			0.023		0.021			0.000		0.000
			(0.027)		(0.027)			(0.001)		(0.001)
Liabilities sq				0.190***	0.189***				0.002	0.002
				(0.044)	(0.044)				(0.002)	(0.002)
N	10,815	10,815	10,815	10,815	10,815	249	249	249	249	249
R-sq	0.184	0.184	0.184	0.187	0.187	0.587	0.587	0.587	0.589	0.589
Country fixed effect	Yes	Yes	Yes	Yes	Yes	Yes	Yes	Yes	Yes	Yes
Year fixed effect	Yes	Yes	Yes	Yes	Yes	Yes	Yes	Yes	Yes	Yes
Clustering level	Bank	Bank	Bank	Bank	Bank	Bank	Bank	Bank	Bank	Bank

Panel B: Regressions with additional control variables 

	Market-to-book	Market-to-book	Market-to-book	Market-to-book	Market-to-book	CDS	CDS	CDS	CDS	CDS
	(1)	(2)	(3)	(4)	(5)	(6)	(7)	(8)	(9)	(10)
Assets	0.070***	0.070***	0.070***	0.077***	0.076***	-0.000	-0.000	-0.000	-0.000	-0.000
	(0.010)	(0.010)	(0.010)	(0.010)	(0.010)	(0.000)	(0.000)	(0.000)	(0.000)	(0.000)
Pre-tax profits	3.298***	3.293***	3.290***	3.270***	3.263***	-0.182	-0.171	-0.182	-0.185	-0.185
	(0.896)	(0.897)	(0.897)	(0.898)	(0.899)	(0.140)	(0.142)	(0.140)	(0.138)	(0.138)
Earning  assets	-0.517***	-0.514***	-0.514***	-0.498**	-0.495**	-0.010	-0.010	-0.010	-0.010	-0.010
	(0.195)	(0.194)	(0.194)	(0.194)	(0.194)	(0.014)	(0.014)	(0.014)	(0.014)	(0.014)
Leverage	0.167	0.167	0.169	0.176	0.178	0.008	0.004	0.008	0.005	0.005
	(0.229)	(0.228)	(0.229)	(0.232)	(0.232)	(0.027)	(0.027)	(0.027)	(0.025)	(0.025)
GDP per capita	0.039	0.044*	0.044*	0.041*	0.046*	0.000	0.000	0.000	0.000	0.000
	(0.024)	(0.025)	(0.025)	(0.024)	(0.026)	(0.001)	(0.001)	(0.001)	(0.001)	(0.001)
Past crisis	0.004	-0.011	-0.011	0.005	-0.009	-0.008*	-0.008*	-0.008*	-0.008*	-0.008*
	(0.048)	(0.048)	(0.048)	(0.048)	(0.048)	(0.004)	(0.004)	(0.004)	(0.004)	(0.004)
Past fiscal cost	-0.083	0.028	0.030	-0.078	0.035	0.223	0.220	0.223	0.232*	0.237*
	(0.570)	(0.576)	(0.577)	(0.568)	(0.576)	(0.138)	(0.139)	(0.140)	(0.139)	(0.142)
Public debt	-0.707***	-0.690***	-0.690***	-0.721***	-0.704***	0.000	-0.000	0.000	0.003	0.004
	(0.109)	(0.110)	(0.110)	(0.109)	(0.110)	(0.009)	(0.009)	(0.009)	(0.009)	(0.009)
Bank stock risk	0.124*	0.122*	0.122*	0.126*	0.125*	0.025***	0.025***	0.025***	0.025***	0.025***
	(0.067)	(0.067)	(0.067)	(0.067)	(0.067)	(0.007)	(0.007)	(0.007)	(0.007)	(0.007)
Liabilities	-0.004		0.013	-0.463***	-0.445***	-0.002		-0.002	-0.008**	-0.009*
	(0.118)		(0.122)	(0.161)	(0.163)	(0.002)		(0.002)	(0.004)	(0.005)
Sum liabilities		0.027					-0.000
		(0.028)					(0.001)
Other liabilities			0.028		0.028			-0.000		-0.000
			(0.027)		(0.027)			(0.001)		(0.001)
Liabilities sq				0.162***	0.162***				0.003	0.004
				(0.041)	(0.041)				(0.002)	(0.002)
N	10,791	10,791	10,791	10,791	10,791	248	248	248	248	248
R-sq	0.208	0.208	0.208	0.210	0.210	0.642	0.640	0.642	0.647	0.648
Country fixed effect	Yes	Yes	Yes	Yes	Yes	Yes	Yes	Yes	Yes	Yes
Year fixed effect	Yes	Yes	Yes	Yes	Yes	Yes	Yes	Yes	Yes	Yes
Clustering level	Bank	Bank	Bank	Bank	Bank	Bank	Bank	Bank	Bank	Bank

The market-to-book ratio is seen to be positively and significantly related to the assets variable as a measure of absolute bank size in regressions 1-5 in Panel A, while the CDS spread does not appear to reflect assets size in regressions 6-10. The positive relationship between bank size and bank valuation suggests a TBTF effect for large banks, even if it also may reflect economies of scale or management.  

Next, the public debt variable negatively and significantly affects the market-to-book ratio in regressions 1 through 5. Public debt thus is negatively capitalized into bank share prices, potentially reflecting that banks cannot be saved as easily in fiscally strapped countries. In the CDS regressions 6 through 10, the public debt variable does not obtain a significant coefficient. Thus public indebtedness does not appear to affect expected credit losses on bank liabilities, at least for senior unsecured bank liabilities.  

Bank risk, proxied by the bank stock risk variable, in turn positively affects the marketto-book ratio in regressions 1-5 (with significance at 10 percent), as well as the CDS spread in regressions 6-10 (with significance at 1 or 5 percent). Bank risk thus benefits bank shareholders, presumably because the financial safety net prevents banks' funding costs from fully reflecting bank risk. All the same, increased bank risk implies larger expected losses on bank liabilities, as reflected by higher CDS spreads. 

The bank liabilities-to-GDP ratio enters the market-to-book regression 1 with a negative but insignificant coefficient, and it is estimated with a coefficient of zero in the CDS regression 6. In regressions 2 and 7, we replace the bank-level liabilities-to-GDP ratio by the system-level liabilities-to-GDP ratio, yielding insignificant estimated coefficients in both regressions. Next, in regressions 3 and 8 the systemic variables are the bank's own liabilities-to-GDP ratio and the ratio of other national banks' liabilities to GDP, again yielding coefficients that are statistically insignificant. Further, regressions 4 and 9 include a bank's own liabilities-to-GDP ratio and the square of this variable. In the market-to-book regression 4, the linear and quadratic liabilities-toGDP variables enter with negative and positive coefficients, respectively, that are both significant at the 1 percent level.  

The estimated coefficients of -0.570 and 0.190 on the linear and quadratic liabilities-toGDP variables in regression 4 imply that the market-to-book ratio declines with the bank's liabilities-to-GDP ratio if the latter ratio is less than 1.5, while it increases with the liabilities-toGDP ratio for higher values of this variable. This suggests that perhaps a very few large banks can obtain increased valuation from larger systemic size at the margin, while the vast majority can benefit from reduced systemic size. Moreover, the estimated coefficients suggest that all banks with a liabilities-to-GDP ratio less than 3.0 (which means all banks in 2008 apart from UBS as seen in Table 1) have a lower valuation on account of their systemic size than a negligibly small bank with a liabilities-to-GDP ratio of zero.  

In the CDS regression 9, the linear and quadratic liabilities-to-GDP terms instead are estimated with coefficients that are statistically insignificant. Regressions 5 and 10 jointly include the systemic variables included in regressions 3-4 and 8-9 with similar outcomes. Results so far suggest that bank valuation increases with absolute bank size, while it declines with systemic size for all banks other than a few very large banks. CDS spreads, instead, appear unrelated to either absolute or systemic bank size. 

The regressions in Panel B of Table 7 include control variables. The market-to-book ratio is seen to be positively and significantly related to pre-tax profits throughout Panel B, while the relationship between the CDS spread and pre-tax profits is negative, but not statistically significant.  The market-to-book ratio is negatively related to the earning assets variable, suggesting that traditional banking activities, involving earning assets, add relatively little value. The CDS spread, in turn, is negatively related to the past crisis dummy, and positively related to the fiscal cost of past crises in regressions 9 and 10 (both variables are significant at the 10 percent level). This suggests that CDS spreads positively reflect past crises that have been very costly, perhaps because the concerned countries have reformed the financial safety net to make costly crisis resolution in the future less likely. In some specification, the market-to-book value (but not the CDS spreads) is further positively related to per capita GDP (at the 10 percent significance level).  

The relationships between bank valuation on the one hand and the bank size and risk variables on the other are not qualitatively affected by the inclusion of controls in Panel B. 

The linear liabilities-to-GDP variables, however, are now estimated with a coefficient of -0.008 that is significant at 5 percent in the CDS regression 9 of Panel B, while the quadratic liabilitiesto-GDP variable obtains a coefficient of 0.003 that is insignificant in this regression. These point estimates suggest that essentially all banks (with liabilities to GDP less than 2.7) can reduce expected losses on their liabilities by increasing their systemic size, as evidence of TBTF.  

The results in both panels of Table 7 suggest that the relationships between the market-to-book ratio and the CDS spread on the one hand and systemic size on the other may be non-linear. One way to deal with this is to introduce a categorical variable indicating whether systemic size exceeds a certain threshold level. The regressions in Table 8 include the Big0.5 variable, which equals one if the liabilities-to-GDP ratio exceeds 0.5 while it is zero otherwise. The table again contains two panels, with Panel A including only the bank and banking-system size and risk variables, and Panel B in addition including a range of control variables. In regressions 1-5 of either panel, the market-to-book value is the dependent variable, while the CDS spread is the dependent variable in regressions 6-10. Regressions 5 and 10 in either panel differ from the other regressions in that the fiscal balance rather than the public debt ratio is the included public finance variable. This leads to a reduced sample size in these regressions, as  fiscal balance information is available from the IMF and OECD only for recent years for many countries.  

The Big0.5 variable enters the market-to-book regression 1 and the CDS regression 6 with negative but insignificant coefficients in Panel A of Table 8. In regressions 2 and 6, an interaction term of Big0.5 with the public debt ratio is included as well, yielding insignificant coefficients in both regressions. Regressions 3 and 7 instead include an interaction term of the Big0.5 variable with the bank stock risk variable. Now the Big0.5 variable obtains a negative coefficient of -0.454 that is significant at the 5 percent level in the market-to-book regression, while its interaction with bank stock risk obtains a positive coefficient of 0.763 that is significant at 10 percent. This suggests that systemically large banks see their valuation increase relatively more with higher bank risk at the margin, as bank risk apparently adds to these banks' TBTF status.   

In the CDS regression 8 of Panel A of Table 8, the Big0.5 variable is estimated with a coefficient of 0.004 that is significant at the 5 percent level, while its interaction with bank stock risk obtains a coefficient of -0.013 that is significant at the 1 percent level. These results suggest that especially systemically large banks can benefit from taking on more risk, as this reduces the expected losses on their bank liabilities on account of strengthening their TBTF status. Again we can consider the implications of systemic size for a bank with mean bank stock risk. Such a bank will see its CDS spread changed on account of its size by -0.0061 percent (or 0.004 – 0.013*0.303). The average-risk, systemically large bank thus faces a slightly lower CDS spread, on account of increased TBTF status. Regressions 4 and 9 jointly include interaction terms of Big0.5 with the public debt and bank stock risk variable, yielding that the Big0.5 variable no longer is statistically significant in regression 4. 

In regressions 5 and 10, as indicated, the fiscal balance variable replaces the government debt variable. In regression 5, we see that the market-to-book ratio is positively and significantly related to the fiscal balance, confirming that the state of public finances is capitalized into bank share prices. The positive coefficient is consistent with the view that countries with sound public finances can afford a more generous financial safety net, implying larger implicit subsidies to the banking sector. The Big0.5 variable enters this regression with a coefficient of -0.360 that is significant at 5 percent, while its interactions with bank risk and the fiscal balance are not estimated to be statistically significant. In the CDS regression 10, the fiscal balance is not priced significantly into the CDS spread. Overall, the results of Panel A of Table 8 suggest that systemically important banks (with average bank risk) have lower valuation on account of TBTS and a slightly lower CDS spread, even if higher risk increase (reduces) bank valuation (CDS spreads) of systemically large banks relatively more. 

Table 8.  The impact of systemic bank size defined by a liabilities-to-GDP ratio exceeding 0.5 

The dependent variable is the market-to-book ratio in columns 1 to 5 and the CDS spread in columns 6 to 10 in both Panel A and Panel B. Market-to-book is the market value of common equity divided by the book value of common equity. CDS is the annual average of daily credit default spreads on a 5-year contract. Assets is natural logarithm of total assets in constant 2000 US dollars. Pre-tax profits is pre-tax profits divided by total assets. Earning assets is earning assets divided by total assets. Leverage is liabilities divided by total assets.  GDP per capita is GDP per capita in constant 2000 dollars. Past crisis is dummy variable that is one if country is not currently experiencing a banking crisis but has experienced a banking crisis before and zero otherwise. Past fiscal cost is fiscal cost of resolving most recent but not current banking crisis divided by GDP. 

Public debt is central government debt divided by GDP. Fiscal balance is ratio of central government revenues minus expenses and minus depreciation of capital to GDP. Bank stock risk is annualized standard deviation of weekly dividend-inclusive bank stock returns. Big0.5 is a dummy variable that equals one if ratio of bank liabilities to GDP exceeds 0.5 and zero otherwise. All regressions are estimated with year and country fixed effects and clustering at the bank level. *, ** and *** denote significance at 10%, 5% and 1% respectively. 

Panel A: Basic regressions 

	Market-to-book	Market-to-book	Market-to-book	Market-to-book	Market-to-book	CDS	CDS	CDS	CDS	CDS
	(1)	(2)	(3)	(4)	(5)	(6)	(7)	(8)	(9)	(10)
Assets	0.073***	0.073***	0.073***	0.073***	0.044***	-0.000	-0.000	-0.000	-0.000	-0.001
	(0.009)	(0.009)	(0.009)	(0.009)	(0.010)	(0.000)	(0.000)	(0.000)	(0.000)	(0.000)
Public debt	-0.773***	-0.770***	-0.775***	-0.772***		-0.018	-0.019	-0.020*	-0.021*
	(0.105)	(0.106)	(0.105)	(0.106)		(0.011)	(0.011)	(0.012)	(0.012)
Fiscal balance					7.096***					0.023
					(1.359)					(0.054)
Bank stock risk	0.129*	0.129*	0.122*	0.122*	0.274***	0.029***	0.029***	0.030***	0.030***	0.031**
	(0.066)	(0.066)	(0.066)	(0.066)	(0.084)	(0.011)	(0.011)	(0.011)	(0.011)	(0.012)
Big0.5	-0.222	-0.031	-0.454**	-0.256	-0.360**	-0.000	-0.000	0.004**	0.003*	0.004*
	(0.146)	(0.310)	(0.193)	(0.340)	(0.158)	(0.001)	(0.001)	(0.002)	(0.002)	(0.002)
Big0.5 * Public debt		-0.449		-0.475			0.000		0.002
		(0.564)		(0.559)			(0.003)		(0.002)
Big0.5 * Bank stock risk			0.763*	0.778*	0.316			-0.013***	-0.013***	-0.011**
			(0.414)	(0.409)	(0.353)			(0.005)	(0.005)	(0.004)
Big0.5 * Fiscal balance					-1.436					-0.007
					(2.591)					(0.015)
N	10,815	10,815	10,815	10,815	4,746	249	249	249	249	192
R-sq	0.185	0.185	0.185	0.185	0.263	0.587	0.587	0.601	0.602	0.644
Country Fixed Effect	Yes	Yes	Yes	Yes	Yes	Yes	Yes	Yes	Yes	Yes
Year Fixed Effect	Yes	Yes	Yes	Yes	Yes	Yes	Yes	Yes	Yes	Yes
Clustering Level	Bank	Bank	Bank	Bank	Bank	Bank	Bank	Bank	Bank	Bank

Panel B: Regressions with additional control variables 

	Market-to-book	Market-to-book	Market-to-book	Market-to-book	Market-to-book	CDS	CDS	CDS	CDS	CDS
	(1)	(2)	(3)	(4)	(5)	(6)	(7)	(8)	(9)	(10)
Assets	0.073***	0.073***	0.073***	0.073***	0.030***	-0.000	-0.000	-0.000	-0.000	-0.000
	(0.010)	(0.010)	(0.010)	(0.010)	(0.011)	(0.000)	(0.000)	(0.000)	(0.000)	(0.000)
Pre-tax profits	3.284***	3.288***	3.271***	3.275***	4.836***	-0.174	-0.175	-0.132	-0.133	-0.233
	(0.896)	(0.898)	(0.896)	(0.897)	(1.328)	(0.141)	(0.141)	(0.135)	(0.135)	(0.153)
Earning assets	-0.515***	-0.516***	-0.516***	-0.517***	-0.661***	-0.011	-0.011	-0.015	-0.016	0.005
	(0.194)	(0.195)	(0.194)	(0.195)	(0.212)	(0.014)	(0.015)	(0.015)	(0.015)	(0.011)
Leverage	0.174	0.181	0.173	0.180	1.065***	0.006	0.006	0.009	0.009	-0.009
	(0.230)	(0.231)	(0.230)	(0.231)	(0.195)	(0.027)	(0.027)	(0.026)	(0.026)	(0.028)
GDP per capita	0.040	0.038	0.039	0.037	0.029	0.000	0.000	0.000	0.000	-0.000
	(0.024)	(0.025)	(0.024)	(0.025)	(0.059)	(0.001)	(0.001)	(0.001)	(0.001)	(0.001)
Past crisis	0.008	0.007	0.011	0.010	-0.353***	-0.008*	-0.008*	-0.010**	-0.010**	-0.008*
	(0.048)	(0.048)	(0.049)	(0.049)	(0.079)	(0.004)	(0.004)	(0.005)	(0.005)	(0.004)
Past fiscal cost	-0.085	-0.103	-0.147	-0.167	14.287***	0.223	0.223	0.294*	0.296*	0.267*
	(0.570)	(0.573)	(0.575)	(0.578)	(2.345)	(0.138)	(0.138)	(0.152)	(0.153)	(0.137)
Public debt	-0.713***	-0.712***	-0.713***	-0.711***		0.000	-0.001	0.002	0.001
	(0.109)	(0.109)	(0.109)	(0.109)		(0.009)	(0.009)	(0.010)	(0.010)
Fiscal balance					4.096***					-0.028
					(1.487)					(0.033)
Bank stock risk	0.126*	0.127*	0.120*	0.120*	0.390***	0.025***	0.025***	0.029***	0.030***	0.025***
	(0.067)	(0.067)	(0.067)	(0.067)	(0.099)	(0.007)	(0.007)	(0.008)	(0.008)	(0.008)
Big0.5	-0.174	-0.012	-0.380**	-0.211	-0.202	-0.001	-0.002	0.004**	0.003	0.004**
	(0.138)	(0.299)	(0.186)	(0.329)	(0.154)	(0.001)	(0.002)	(0.002)	(0.002)	(0.002)
Big0.5 * Public debt		-0.381		-0.407			0.001		0.004
		(0.551)		(0.546)			(0.003)		(0.003)
Big0.5 * Bank stock risk			0.678*	0.692*	-0.242			-0.018**	-0.018**	-0.014***
			(0.405)	(0.401)	(0.335)			(0.007)	(0.007)	(0.005)
Big0.5 * Fiscal balance					-0.256					-0.014
					(2.263)					(0.019)
N	10,791	10,791	10,791	10,791	4,729	248	248	248	248	191
R-sq	0.208	0.208	0.209	0.209	0.306	0.641	0.641	0.664	0.665	0.739
Country Fixed Effect	Yes	Yes	Yes	Yes	Yes	Yes	Yes	Yes	Yes	Yes
Year Fixed Effect	Yes	Yes	Yes	Yes	Yes	Yes	Yes	Yes	Yes	Yes
Clustering Level	Bank	Bank	Bank	Bank	Bank	Bank	Bank	Bank	Bank	Bank

The regressions in Panel B of Table 8 are analogous to those reported before but they include the set of control variables. Point estimates of coefficients in regressions 3 and 8 continue to imply that a systemically large bank with average risk has a relatively low valuation and a low CDS spread, while additional bank risk increases bank valuation and reduces CDS spreads relatively more for systemic banks. Note, however, that the coefficient for the Big0.5 variable, while negative, is no longer statistically significant in the bank valuation regression 5 that includes the fiscal balance variable.   

The estimation results so far can be used to assess the overall impact of systemic size on bank valuation. To do this, we make use of the estimated coefficients in regression 3 of Panel A of Table 8. To wit, a systemically large bank (with Big0.5 = 1) with the mean level of bank stock risk (i.e., with bank stock risk equal to 0.303 from Table 4) is estimated to obtain a valuation discount of 22.3 percent (as -0.454 + 0.763*0.303 = -0.223) on account of its systemic size. Note that this estimated discount of 22.3 percent for the share price of a systemically large bank with mean bank stock risk closely corresponds to the estimated discount of 22.2 percent on account of systemic size in regression 1.  

This suggests that systemically important banks face a strong incentive to downsize or split up in order to eliminate the valuation discount. However, a systemically important bank that decides to downsize will also reduce its absolute size, thereby reducing the premium it receives on account of its absolute size (given that the assets variable is estimated with a positive and significant coefficient of 0.073 in regression 3 of Panel A of Table 8). As an example, we can consider that the average systemically important bank (with mean assets of 26.902 in 2008 in 

Table 6) downsizes to the average systemically unimportant bank (with mean assets of 22.250 in 2008). This reduces such a bank's premium on account of large absolute size by 34.0 percent (as 0.073*(26.902 – 22.250) = 0.340). This would make the overall valuation effect of downsizing, accounting for reduced systemic and absolute size, negative at -11.7 percent (as 22.3 – 34.0 = -11.8).  

These calculations of the impact of downsizing on the valuation of the average bank, however, fail to take into account differences in country size. Thus, they do not recognize that a systemically important bank located in a small country has to reduce its absolute size relatively little to obtain a significant reduction in systemic size. Because of this, systemically large banks located in small countries do face incentives to downsize, as this would reduce their discount on account of systemic size relatively more, and reduce their premium on account of absolute size relatively little. 

The limits imposed by the state of public finances on the financial safety net should be particularly important during a time of financial crisis. Therefore, we next consider how the market-to-book ratio and the CDS spread depend on the public finance variables in 2007 and 2008. In particular, regression 1 of Table 9 re-estimates the market-to-book regression 4 of Panel B of Table 8 including the public debt variable. This regression is estimated with data only for 2008, without country fixed effects, and with errors clustered at the country level. Further, regression 2 of Table 9 is a market-to-book ratio regression including the public debt variable with data for 2007-2008 and including bank-level fixed effects. In regression 1, assets is not statistically significant, but in regression 2 it enters with a negative and statistically significant coefficient, indicating that at a time of financial crisis an increase in absolute assets size is valued negatively. The public debt variable is not significant in regression 1 which omits country or firm fixed effects, but it enters with a negative coefficient that is significant at 10 percent in regression 2 suggesting that increases in public debt are priced negatively during a financial crisis. Bank stock risk enters with a positive and significant coefficient in regression 1, but it obtains a negative and significant coefficient in regression 2. Thus, bank risk is priced positively on a cross-section basis in 2008 if we do not control for country or firm fixed effects, but additions to risk between 2007 and 2008 are priced negatively while controlling for bank-level fixed effects. This suggests a reduced pricing benefit of risk on account of a bank's contingent claim on the financial safety net during a financial crisis.  

Table 9.  Determinants of the market-to-book ratio and the cds spreads during 2007-2008 

Dependent variable is market-to-book ratio in regressions 1-2 and 4-5 and the CDS spread in regressions 3 and 6. Market-to-book is market value of common equity divided by book value of common equity. CDS is annual average of daily credit default spreads for 5-year contracts. Assets is natural logarithm of total assets in constant 2000 US dollars. Pre-tax profits is pre-tax profits divided by total assets. Earning assets is earning assets divided by total assets. Leverage is liabilities divided by total assets. GDP per capita is GDP per capita in constant 2000 dollars. Past crisis is dummy variable that is one if country is not currently experiencing a banking crisis but has experienced a banking crisis before and zero otherwise. Past fiscal cost is fiscal cost of resolving most recent but not current banking crisis divided by GDP. Public debt is central government debt divided by GDP. Fiscal balance is ratio of central government revenues minus expenses and minus depreciation of capital to GDP. Bank stock risk is annualized standard deviation of weekly dividend-inclusive bank stock returns. Big0.5 is a dummy variable that equals one if ratio of bank liabilities to GDP exceeds 0.5 and it is zero otherwise. Big0.5, 2007 is a dummy variable that equals one if ratio of bank liabilities to GDP exceeds 0.5 in 2007 and it is zero otherwise. Regressions 1 and 4 are estimated with clustering at the country level. Regressions 2-3 and 4-5 contain bank fixed effects. *, ** and *** denote significance at 10%, 5% and 1% respectively. 

	Market-to-book	Market-to-book	CDS	Market-to-book	Market-to-book	CDS
	(1)	(2)	(3)	(4)	(5)	(6)
Sample period	2008	2007 and 2008	2007 and 2008	2008	2007 and 2008	2007 and 2008
Assets	-0.008	-1.007***	-0.002	-0.002	-0.968***	0.000
	(0.024)	(0.136)	(0.008)	(0.025)	(0.138)	(0.004)
Pre-tax profits	1.336***	-0.754	0.182	1.385***	-0.350	0.033
	(0.469)	(0.635)	(0.205)	(0.437)	(0.631)	(0.115)
Earning assets	-0.781**	-0.871	-0.141*	-0.658*	-0.191	-0.024
	(0.334)	(0.665)	(0.074)	(0.357)	(0.718)	(0.048)
Leverage	0.687***	5.784***	-0.149	0.626***	5.634***	-0.150**
	(0.178)	(0.872)	(0.119)	(0.197)	(0.877)	(0.062)
GDP per capita	-0.040***	0.229**	0.003	-0.036***	0.205*	0.001
	(0.014)	(0.113)	(0.004)	(0.012)	(0.120)	(0.003)
Past crisis	0.047			0.019
	(0.178)			(0.231)
Past fiscal  cost	-2.471*			-1.942
	(1.420)			(1.430)
Public debt	-0.142	-1.383*	-0.012
	(0.479)	(0.788)	(0.055)
Fiscal balance				-1.135	6.003***	-0.098**
				(1.454)	(2.013)	(0.045)
	(1.325)
Big0.5 * Fiscal balance				5.214***
				(1.727)
Big0.5 * Bank stock risk	0.394			0.500
	(0.577)			(0.394)

Regression 3 has the CDS spread as the dependent variable and, as regression 2, it is estimated with data for 2007 and 2008, and it includes firm-level fixed effects. In this regression, the bank stock risk variable obtains a positive and significant coefficient, indicating that innovations in bank risk are associated with higher CDS spreads during this period.  

Regressions 4-6 in Table 9 are similar to regressions 1-3 but they include the fiscal balance rather than the public debt as the public finance variable. In regression 4 with 2008 data, we see a positive and significant coefficient for the interaction of the Big0.5 variable and the fiscal balance. Thus, the market-to-book ratio of systemically large banks is higher in countries with a higher fiscal balance which is evidence of a TBTS effect. In the market-to-book ratio and CDS regressions 5 and 6 including bank fixed effects, we see a positive and negative coefficient for the fiscal balance variable, respectively, indicating that an improvement of the fiscal balance between 2007 and 2008 is priced positively and negatively into bank share prices and CDS spreads, respectively. Especially the negative pricing of the fiscal balance into the CDS spread suggests a TBTS effect, as there is no apparent alternative explanation for this relationship (for instance, through the implication of the current fiscal balance on future corporate income taxation). 

Table 9.  Determinants of the market-to-book ratio and the cds spreads during 2007-2008, cont’d: 

	Market-to-book	Market-to-book	CDS	Market-to-book	Market-to-book	CDS
	(1)	(2)	(3)	(4)	(5)	(6)
Bank stock risk	0.303***	-0.243***	0.018*	0.283***	-0.138	0.012**
	(0.083)	(0.086)	(0.010)	(0.088)	(0.090)	(0.005)
Big0.5	-0.478			-0.384**
	(0.811)			(0.185)
Big0.5 * Public debt	0.395
Big0.5,  2007 * Public debt		2.085	0.027
		(2.159)	(0.065)
Big0.5, 2007 * Fiscal balance					-1.272	-0.001
					(6.707)	(0.113)
Big0.5, 2007 * Bank stock risk		0.260	-0.013		0.421	-0.006
		(0.394)	(0.011)		(0.440)	(0.008)
Constant	2.987***	11.654***	0.314*	2.602***	10.347**	0.098
	(0.865)	(4.506)	(0.185)	(0.676)	(4.519)	(0.173)
N	676	1670	107	642	1,467	91
R-sq	0.139	0.907	0.889	0.142	0.903	0.959
Year fixed effect	No	Yes	Yes	No	Yes	Yes
Bank fixed effect	No	Yes	Yes	No	Yes	Yes
Clustering Level	Country	None	None	Country	None	None