The Effect of TBTF Deregulation on Bank Cost of Funds

Lazarus Angbazo and Anthony Saunders

Center for Financial Institutions Working Papers from Wharton School Center for Financial Institutions, University of Pennsylvania

Abstract: This paper tests the hypothesis that changes to the "too-big-to-fail" (TBTF) doctrine under the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) increased the risk of deposit loss and the cost of funds for large banks. Furthermore, the paper analyzes the implications of the National Depositor Preference Law of 1993 on the priority, risk, and cost of non-deposit funds in banking. One consistent finding is that the systematic risk coefficient for large banks declined sharply after the passage of FDICIA. In addition, the average cost of deposits and non-deposit funds were lower in the later period, consistent with a generally lower level of interest rates as well as a reduction in the required risk premium. The data did not show a corresponding decline in the systematic risk or cost of funds for small banks. Finally we examined the stock market reaction of the sample banks to the events leading up to FDICIA's passage. In general, the distribution of wealth effects is consistent with the hypothesis that the impact of reduced deposit coverage for failing banks was confined to the large bank segment.

This paper was presented at the Financial Institutions Center's conference on Performance of Financial Institutions, May 8-10, 1997.

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