IDENTIFY TOO BIG TO FAIL BANKS AND CAPITAL INSURANCE: AN EQUILIBRIUM APPROACH

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Abstract

The objective of this paper is develop a rational expectation equilibrium model of capital insurance to identify too big to fail banks. The main results of this model include (1) too big to fail banks can be identified explicitly by a systemic risk measure, loss betas, of all banks in the entire financial sector; (2) the too big to fail feature can be largely justified by a high level of loss beta; (3) the capital insurance proposal benefits market participants and reduces the systemic risk; (4) the implicit guarantee subsidy can be estimated endogenously; and lastly, (5) the capital insurance proposal can be used to resolve the moral hazard issue.
We implement this model and document that the too big to fail issue has been considerably reduced in the pro-crisis period. As a result, the capital insurance proposal could be a useful macro-regulation innovation policy tool.

Keywords: Systemic Risk, Too Big To Fail, Capital Insurance

Received: 16.03.2017

Accepted: 31.07.2017

How to cite this paper: Ivanov, K. (2017). Identify too big to fail banks and capital insurance: An equilibrium approach. Risk Governance and Control: Financial Markets & Institutions, 7(4), 62-87. https://doi.org/10.22495/rgc7i4art7