Are European Banks Still Too-Big-to-Fail? The Impact of Government Interventions and Regulatory Reform on Bailout Expectations in the EU

Abstract

I investigate the implications of government interventions and regulatory reform on too-big-too-fail expectations in the European banking sector. Evidence from stock returns over the period 1993 to 2016 suggests that large European banks have long benefitted and continue to benefit from implicit government guarantees. I document that investors are willing to accept lower risk-adjusted returns for large bank stocks relative to small bank stocks, because they anticipate that governments absorb part of these stocks’ downside risk during financial crises. Recent regulatory reform introducing bail-in and a common standardized resolution framework for European banks were successful in reducing implicit guarantees at first, but became less credible after the effective implementation of these rules came into question in early 2016.