How Does Moral Hazard Impact Critical Market Banking Performance?

Corey J. M. Williams
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Corey J. M. Williams: Shippensburg University, Pennsylvania, U.S.A.

American Business Review, 2025, vol. 28, issue 1, 103-142

Abstract: The degree to which financial institutions form expectations of policy intervention despite their own risk appetites lies at the heart of macrofinancial regulations such as the Dodd-Frank and Consumer Protection Acts. The effectiveness of these policies hinge on the assumption that large banks are the only banks that are too-big-to-fail (TBTF). However, alternative perspectives posit that banks may be too-complex-to-fail, regardless of their size. To remedy competing TBTF definitions, we propose a new criterion to identify potential TBTF banks by their relative involvement in so-called critical markets, considerate of both bank size and complexity. We estimate a restricted translog semiparametric smooth coefficient seemingly unrelated regressions model (SPSC SUR) wherein model elasticities are functions of nonperforming assets, a proxy for moral hazard, to derive nonperformance-adjusted returns-to-scale estimates for critical market banks from 2001 through 2023. Over our full sample, the median critical market bank tends to operate under increasing returns-to-scale while most critical market banks exhibit decreasing or constant returns-to-scale. Results taken over the past two decades suggest that most TBTF banks have exhausted their economies of scale concurrently alongside the shrinking competitive landscape.

Keywords: Scale Economies; Too-Big-to-Fail; Semiparametric Smooth Coefficient; Seemingly Unrelated Regressions (search for similar items in EconPapers)
JEL-codes: C14 G21 L25 (search for similar items in EconPapers)
Date: 2025
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Persistent link: https://EconPapers.repec.org/RePEc:ris:ambsrv:0129

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