‘Too big to fail’: Effects on competition and implications for banking supervision

Despite a raft of important qualitative reservations and at best poor empirical evidence, the argument that, in case of business problems, large banks are more likely to be bailed out by government intervention than smaller banks (‘too big to fail’) cannot be dismissed entirely. The question, though, is whether or to what extent this has any implications for competition or the stability of the banking system. Under realistic assumptions, especially with respect to incentives for bank management and shareholders, too big to fail hardly leads to excessive risk taking by large banks. The impact of too big to fail on a bank's rating and, accordingly, its refinancing conditions is only marginal, as a breakdown of the various rating components clearly documents. This suggests that the effects on competition of too big to fail come nowhere close to the refinancing advantages enjoyed by public sector banks in Germany. The refinancing advantage of the Landesbanken afforded by state guarantees (Anstaltslast and Gewährtragerhäftung) comes to as much as 50 basis points. Given the continual narrowing of lending margins, an advantage on this scale plays a decisive role in competition. Too big to fail has substantial implications for the architecture of banking supervision. Suitable institutional arrangements need to be created in order to deal with large banks in case of a, potentially systemic, crisis. With banking becoming increasingly global and the number of cross‐border mergers on the rise, this requires solutions at an international, if not at a global, level. Implementing the concept of a European Liko‐Bank, as suggested by the Bundesbank, will require that the supervisory authorities and the European System of Central Banks (ESCB) first create appropriate public sector counterparts.