Are Banks Too Big to Fail or Too Big to Save?
Banks, financial institutions, and even big corporations that have their weight in the national economy may sometimes be subjected to adversities that require them to make tough decisions to maintain their viability. However, at times, this proves challenging with no way out. In such cases, and given the positive contribution that these corporations or institutions have had on the economy and since they are considered as one of the key players whose demise may lead to national economic or financial crisis, countries opt for rescuing them through specially designed packages. Here, you will learn more about the "too big to fail" notion within the banking sector and when countries rescue banks. What are the criteria drawn by the United States to rescue struggling banks? Is any bank eligible for rescuing?
Deteriorating public finances around the world raise doubts about countries' abilities to bail out their largest banks. For an international sample of banks, this paper investigates the impact of government indebtedness and deficits on bank stock prices and credit default swap spreads. Overall, bank stock prices reflect a negative capitalization of government debt and they respond negatively to deficits. The authors present evidence that in 2008 systemically large banks saw a reduction in their market valuation in countries running large fiscal deficits. Furthermore, the change in bank credit default swap spreads in 2008 relative to 2007 reflects countries' deterioration of public deficits. The results of the analysis suggest that some systemically important banks can increase their value by downsizing or splitting up, as they have become too big to save, potentially reversing the trend to ever larger banks. The paper also documents that a smaller proportion of banks are systemically important – relative to gross domestic product – in 2008 than in the two previous years, which could reflect private incentives to downsize.
Source: World Bank, https://openknowledge.worldbank.org/handle/10986/3844
This work is licensed under a Creative Commons Attribution 3.0 IGO License.