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Research paper

The influence of systemic importance indicators on banks’ credit default swap spreads

Jill Cetina and Bert Loudis
Journal of Risk Management in Financial Institutions, 9 (1), 17-31 (2016)
https://doi.org/10.69554/BHSL8274

Abstract

This paper examines the relationship between banks’ observed credit default swap (CDS) spreads and possible measures of systemic importance. The authors use five-year CDS spreads from Markit with an international sample of 71 banks to investigate whether market participants are giving them a discount on borrowing costs based on the expectation that governments would consider them ‘too big to fail’. They find a consistent, statistically significant negative relationship between five-year CDS spreads and nine different systemic importance indicators using a generalised least squares (GLS) model. The paper finds that banks perceived as too big to fail have CDS spreads 44–80 basis points lower than other banks, depending on the asset-size threshold and controls used. Additionally, the study suggests that market participants pay more attention to asset size than to a more complex measure, such as designation as a globally systemically important bank (G-SIB), that includes additional factors, such as substitutability and interconnectedness. Lastly, the model suggests that asset size acts as a threshold effect, rather than a continuous effect with the best fitting models using asset-size thresholds of US$50bn–150bn.

Keywords: banking; too big to fail; size effect; heightened prudential regulation; CDS spreads; systemic importance

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Author's Biography

Jill Cetina is on detail to the OFR from the Office of the Comptroller of the Currency. Her main interests are the Basel III liquidity standard, liquidity stress testing and evaluating interest rate risk. Jill previously held positions at the Federal Reserve Board (2007–2010) and US Treasury Department (1998–2007). She holds a BA from Grinnell College and an MPA from Princeton, and is a CFAw charterholder.

Bert Loudis is a financial analyst in policy studies at the Office of Financial Research. Prior to OFR, Bert has worked at the Office of the Comptroller of the Currency and the Trade Partnership, a private consulting firm. Bert holds a Master of Science in Finance degree and a BS from American University.

Citation

Cetina, Jill and Loudis, Bert (2016, January 1). The influence of systemic importance indicators on banks’ credit default swap spreads. In the Journal of Risk Management in Financial Institutions, Volume 9, Issue 1. https://doi.org/10.69554/BHSL8274.

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cover image, Journal of Risk Management in Financial Institutions
Journal of Risk Management in Financial Institutions
Volume 9 / Issue 1
© Henry Stewart
Publications LLP

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