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From Banking and Finance Law Daily, April 10, 2014

Study on bank bond spreads finds diminishing “too big to fail” influences; policy changes effective

By Thomas G. Wolfe, J.D.

The Clearing House has released its commissioned study, conducted by the management consulting firm of Oliver Wyman, examining data for bond spreads during the period of 2009 to 2013 among U.S. Bank Holding Companies (BHCs) to better determine “too big to fail” (TBTF) perceptions and effects since the financial crisis. The April 2014 study, entitled Do Bond Spreads Show Evidence of Too Big To Fail Effects? and authored by John Lester and Aditi Kumar, finds that, by 2013, any funding cost differences among large banks that previously existed have largely disappeared. Moreover, even in earlier periods in which cost differences for bond spreads concerning U.S. global systemically important banks (G-SIBs) may be perceived as an “advantage,” the advantage could be due to factors other than TBTF perceptions.

Further, in an April 10, 2014, release, The Clearing House maintains that the study’s findings “strongly suggest that recent regulatory reforms have dramatically changed market perceptions of risk and funding costs today.”

Background. The Clearing House (TCH), the oldest banking association and payments company in the United States, is owned by the world’s largest commercial banks. Among other things, as a nonpartisan advocacy organization, TCH addresses important banking issues through its comment letters, amicus briefs, white papers, and other publications.

In November 2013, TCH began a series of working papers in assessing whether large banks truly enjoy some TBTF advantage, examining key issues and evidence related to the material benefits enjoyed, and costs borne, by large banks. The first working paper launched the debate by identifying the right questions for policymakers to consider (see Banking and Finance Law Daily, Nov. 7, 2013). In its second working paper, Access to Deposit Insurance and Lender-of-Last-Resort Liquidity, TCH examined whether large banks benefit disproportionately from federal deposit insurance and liquidity programs, or from the various types of extraordinary support provided by the U.S. government in response to the historic challenge facing the economy during the financial crisis of 2008-09 (see Banking and Finance Law Daily, Jan. 23, 2014).

Similarly, in March 2014, Oliver Wyman conducted a study for TCH, entitled Do Deposit Rates Show Evidence of Too Big To Fail Effects?, to contribute to the growing body of research regarding the measurement of TBTF effects on the funding costs of financial institutions. The study sought to measure the differences in deposit funding costs by applying the methodology pioneered by earlier researchers—expanding upon and updating a version of the same source data. However, Senators Sherrod Brown (D-Ohio) and David Vitter (R-La) challenged the results of that March 2014 Oliver Wyman study, characterizing it as an “industry-funded study” (see Banking and Finance Law Daily, March 20, 2014).

In its latest undertaking, TCH again has sponsored Oliver Wyman to conduct the April 2014 study, Do Bond Spreads Show Evidence of Too Big To Fail Effects?

More recent data. The April 2014 study notes that there have only been a couple of prior studies offering empirical assessments of whether bond spreads are lower for large or systemically important institutions, and whether this differential may be due to TBTF perceptions. However, neither of those two studies looked at bond spreads for 2012 and 2013. According to Oliver Wyman, during the 2012 and 2013 period, “there have been substantial efforts by U.S. financial policymakers to address TBTF concerns, including finalizing a range of enhanced prudential standards for the largest banking firms and providing more clarity about the process by which the FDIC could impose losses on the creditors of a large complex financial firm that failed without endangering the overall financial system.”

In contrast, the April 2014 Oliver Wyman study emphasizes that it “seeks to assess recent evidence on funding cost differentials” among U.S. BHCs “to better inform the debate about the future of financial reform in the U.S.” In particular, the study measures “differences in market spreads observed from 2009-2013 for senior unsecured bonds issued by U.S. BHCs.”

Findings. In reaching its findings on the collected data, Oliver Wyman notes that it used “an analytical model very similar” to that used in a 2013 study by Acharya, Anginer, and Warburton. Generally, the Oliver Wyman study found that: (i) in 2009, bonds issued by G-SIBs traded at spreads more than 100 basis points less than bonds issued by other U.S. BHCs; (ii) this bond spread differential for G-SIBs declined in subsequent years; (iii) the sizeable G-SIBs funding differential of 2009 becomes insignificant by 2013; and (iv) these estimated funding spread differences incorporate effects other than TBTF perceptions—such as increasing firm size.

In addition, the study indicates that it describes and clarifies the “assumptions that are implicitly or explicitly made to support the interpretation of measured funding cost differences as specifically TBTF effects.”

Conclusions. Based on its findings, the April 2014 study by Oliver Wyman for TCH concludes:

  1. There is not any strong evidence indicating that differences in bond spreads between G-SIBs and other BHCs can be consistently attributed to TBTF perceptions over the 2009-2013 period.

  2. The measured G-SIB funding advantage continues to decline and becomes statistically insignificant by 2013.

  3. Even in the years that a G-SIB bond spread advantage is observed, the advantage cannot necessarily be attributed to TBTF related factors.

  4. Firms with greater than $100 billion in assets also have funding cost advantages relative to smaller peers, and these advantages are consistent with the general pattern observed for G-SIBs from 2009-2013.

  5. Generally, G-SIBs had a spread advantage (of 104 basis points) in 2009, which steadily declined to a funding cost disadvantage (of 18 basis points) in 2013.

  6. The bond spread advantages of G-SIBs have declined significantly in the post-financial crisis period.

Underscoring this final point, Oliver Wyman’s study states that its results are “consistent with the hypothesis that post-crisis policy changes in the U.S. meant to address TBTF concerns have had a gradual but economically significant impact, especially in the last one to two years.”

Companies: Oliver Wyman; The Clearing House

MainStory: TopStory BankHolding BankingOperations DoddFrankAct FinancialStability

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