A quality and risk-adjusted cost function for banks: Evidence on the ?too-big-to-fail? doctrine

Abstract

We estimate a multiproduct cost function model incorporating measures of bank output quality and the probability of failure. We model a bank's uninsured deposit price as an endogenous variable depending on the bank's output level, output quality, financial capital level, and risk measures. Accounting for these aspects in the cost model significantly affects measures of scale and scope economies. We find evidence that the “too-big-to-fail” doctrine significantly affects the price a bank pays for its uninsured deposits. For large banks, an increase in size, holding default risk and asset quality constant, significantly lowers the uninsured deposit price.