This post is the fourth in a series of thirteen Liberty Street Economics posts on Large and Complex Banks. For more on this topic, see this special issue of the Economic Policy Review.
In the previous post, João Santos showed that the largest banks benefit from a bigger discount in the bond market relative to the largest nonbank financial and nonfinancial issuers. Today’s post approaches a complementary Too-Big-to-Fail (TBTF) question—do banks take on more risk if they’re likely to receive government support? Historically, commentators have expressed concerns that TBTF status encourages banks to engage in risky behavior. However, empirical evidence to substantiate these concerns thus far has been sparse. Using new ratings from Fitch, we tackle this question by examining how changes in the perceived likelihood of government support affect bank lending policies.