Evidence from shadow price of equity on “Too-Big-to-Fail” Banks

This paper estimates the shadow price of equity for U.S. commercial banks over 2001–2018 using nonparametric local-linear estimators of the underlying cost frontier and tests the existence of “Too-Big-to-Fail” (TBTF) banks. Evidence for the existence of TBTF banks is found. We find that a negative correlation exists between the shadow price of equity and the size of banks in each year, suggesting that big banks pay less for equity than small banks. In addition, in each year there are more banks with a negative shadow price of equity in the fourth quartile based on total assets than in the other three quartiles. The data also reveal that for each year, the estimated mean shadow price of equity for the 50 largest banks is smaller than the mean price of deposits, even though equity is commonly viewed as a riskier asset than deposits. Finally, we find that the top 10 largest banks are willing to pay much more at the start of the global financial crisis and after the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 than the other periods. These results imply that these regulations are effective in reducing the implicit subsidy, at least for the top 10 largest banks. However, it is also evident that the recapitalization has imposed significant equity funding costs for the top 10 largest banks.