The Role of "Too Big to Fail" Status in Bank Merger Activity

Parker Normann

Advisor: Bryan D Caplan, PhD, Department of Economics

Carow Hall, Sm. Conf R
December 02, 2007, 07:00 PM to 07:00 PM


Abstract In an attempt to promote stability and safeguard public deposits the U.S. federal government has actively involved itself in the banking system. This dissertation examines a linchpin of federal banking policy, the Federal Deposit Insurance Corporation (FDIC). The main function of the FDIC is to provide absolute guarantees on insured deposits up to a set limit. This amounts to a federal subsidy for banks, and the greater risks banks assume, the greater the amount of the subsidy. Attempts by policy makers to undue the undesirable aspects of the subsidy have succeeded in limiting the extent of coverage to small banks but have codified into law that the largest banking institutions are considered ?too big to fail? (TBTF). This special status granted to TBTF banks confers upon them a funding advantage not available to their smaller competitors. This imbalance creates an incentive for banks to merge in order to create a bank considered TBTF, or for existing TBTF banks to purchase smaller banks; in either event the purpose is to capture the gains from the too big to fail status. This potential cause of bank mergers has only recently begun to enter the banking literature and has yet to be formerly tested. The purpose of this dissertation is to both layout the economic theory and to test empirically the role of too big to fail status in bank merger activity.