The market impact of systemic risk capital surcharges

Abstract

This paper tests the ‘Too-Big-to-Fail’ hypothesis that whether being designated as a global systemically important bank (G-SIB) has an impact on the credit default swap (CDS) price of the bank, thereby reducing its credit risk. We find surprising evidence that the CDS spreads of a bank increase (decrease) after the announcement of a higher (lower) capital surcharge. However, this effect is temporary, as the mean CDS spreads revert to preannouncement level, dropping sharply after the initial rise. These findings create a puzzle by implying that a higher capital surcharge requirement and more stringent regulation could outweigh the implicit subsidy advantages of being too-big-to-fail.