Systemic at Home: the Persistence of a Too-Big-to-Fail Premium in Europe

We quantify the implicit too-big-to-fail (TBTF) funding advantage of large Eu-ropean banks using CDS market data. Applying a reduced-form asset pricing frame-work, we decompose spreads into a fundamental credit-risk component and a resid-ual wedge attributable to implicit government support. We do not find evidence that G-SIB designation is associated with lower funding costs once bank funda-mentals and sovereign factors are taken into account. By contrast, banks whose assets exceed half of home-country GDP enjoy at least 30% lower credit spreads than those of otherwise comparable peers. A time-varying specification reveals that the TBTF wedge persists through 2024, and while average spreads are significantly lower across the board compared to the period around the Great Financial Crisis, the implicit bailout guarantee as a proportion of total spreads has not diminished in recent years. Moreover, the results suggest that the TBTF premium depends on sovereign fiscal strength: the funding advantage of systemic banks declines when home-sovereign CDS spreads rise. This points to Europe’s TBTF problem being primarily domestic in nature and relates to the strength of the home sovereign.