Have Too-Big-To-Fail Expectations Diminished? Evidence from the European Overnight Interbank Market

Abstract

Using the Eurosystem’s proprietary interbank loan data from June 2008–June 2020, we show that larger European banks have had a lower cost of overnight borrowing than smaller banks. The size premium remains significant after controlling for a large set of other factors but has decreased over time, especially in countries that were stricken by the Sovereign Debt Crisis. A difference-in-differences analysis suggests that the decline in the size premium is related to the actual bail-in events, not to the implementation dates of the Bank Recovery and Resolution Directive as such. This finding is robust to controlling for the effect of the ECB’s long-term refinancing operations. Overall, the results suggest that the regulatory move towards bail-in rather than bailout policies to deal with financially distressed banks has reduced the too-big-to-fail expectations concerning large banks.