Uneven decrease in market expectations of government support for systemically important banks

Publication 23 June 2021

An article in the Riksbank’s periodical The Economic Review (Swedish title: Penning- och valutapolitik) demonstrates a decline since 2012 in market expectations of government support for systemically important banks. Nevertheless, expectations that the state will intervene if a systemically important bank were to encounter financial problems remain, which emphasises the importance of continuing to develop the regulatory framework.

Because systemically important banks – the failure of which would have a major adverse impact on the financial system and the economy in general – are often protected by the government if they experience financial difficulties, they receive lower interest rates on funding that reduce their funding costs compared with other banks. This is what is colloquially known as a “too-big-to-fail premium” (TBTF premium).

The failure of a TBTF bank could have major cross-border consequences. From the perspective of a smaller country, the need for establishing sufficiently strict minimum rules at the global level is therefore even more important. After the global financial crisis of 2008–2009, decision-makers launched a broad array of reforms for addressing the TBTF problem. This resulted in, among other things, higher capital and liquidity requirements for the banks and new frameworks for resolution.

The new regulations have been effective. TBTF premiums have decreased globally, but they significantly vary over time and by region.

The authors of the article[1] have analysed the TBTF premium for 53 systemically important banks worldwide for the period January 2004 to March 2021 – thereby spanning years prior to the global financial crisis and into the crisis caused by the coronavirus pandemic. They identified that the premiums have declined for Europe and United States and less so for Asia. But also within Europe there is a significant variation. TBTF premiums have declined a lot more in the Nordic region than in the rest of Europe.

Historically, there has been a connection between the size of the bank and the TBTF premium, but this has changed with the new regulations. A bank’s size still has significance but to a lesser extent than previously. Instead, the size of the bank’s capital buffer and its profitability have become more relevant for the premium.

Banks that have a larger buffer are perceived to have a lower TBTF status than prior to the reforms. This highlights the importance of continuing to develop the regulations for further reducing TBTF premiums worldwide, says Marianna Blix Grimaldi, Senior Analyst at the Debt Office and one of the article’s authors.

The coronavirus pandemic is considered to have led to increased TBTF premiums in Europe and North America. No increase has been seen in the Nordic countries and Asia.

Read the full article.

[1] Marianna Blix Grimaldi and Mats Christoffersson, Swedish National Debt Office; Yuuki Ikeda, Bank of Japan (previously Bank for International Settlements); and Jonas Niemeyer, the Riksbank