We found that while views varied among market participants with whom  we spoke, many believed that recent regulatory reforms have reduced but  not eliminated the likelihood the federal government would prevent the  failure of one of the largest bank holding companies. Credit rating  agencies and large investors cited the new Orderly Liquidation Authority,  which gives the Federal Deposit Insurance Corporation new authority to  resolve large financial firms outside of the bankruptcy process, as a key  factor influencing their views. While several large investors viewed the  resolution process as credible, others cited potential challenges, such as  the risk that multiple failures of large firms could destabilize markets. Remaining market expectations of government support can benefit large  bank holding companies to the extent that these expectations affect  decisions by investors, counterparties, and customers of these firms. Analysis of Funding Cost Differences between Large and Small Banks

We analyzed the relationship between a bank holding company’s size  and its funding costs, taking into account a broad set of other factors that  can influence funding costs. To inform this analysis and to understand the  breadth of methodological approaches and results, we reviewed selected  studies that estimated funding cost differences between large and small  financial institutions that could be associated with the perception that  some institutions are too big to fail. Studies we reviewed generally found  that the largest financial institutions had lower funding costs during the  2007-2009 financial crisis but that the difference between the funding  costs of the largest and smaller institutions has since declined. However,  these empirical analyses contain a number of limitations that could  reduce their validity or applicability to U.S. bank holding companies. For  example, some studies used credit ratings, which provide only an indirect  measure of funding costs. Our analysis, which addresses some limitations of these studies,  suggests that large bank holding companies had lower funding costs than  smaller ones during the financial crisis but provides mixed evidence of  such advantages in recent years. However, most models suggest that  such advantages may have declined or reversed. These models estimate  the relationship between bank holding companies’ bond funding costs  and their size, while also controlling for other drivers of bond funding  costs, such as bank holding company credit risk. Key features of our  approach include the following:
U.S. bank holding companies. To better understand the relationship  between bank holding company funding costs and size in the context  of the U.S. economic and regulatory environment, we only analyzed  U.S. bank holding companies. We used bond yield spreads—the difference  between the yield or rate of return on a bond and the yield on a  Treasury bond of comparable maturity—as our measure of bank  holding company funding costs because they are a direct measure of  what investors charge bank holding companies to borrow money and  because they are sensitive to credit risk and hence expected  government support. Furthermore, as we have noted, many  market participants we spoke with believe that recent regulatory reforms  have reduced but not eliminated the perception of “too big to fail” and  both they and Treasury officials indicated that additional steps were  required to address “too big to fail.”As discussed, changes over time in  our estimates of the relationship between bond funding costs and size  may reflect changes in one or more components of investors’ beliefs  about government support—such as their views on the likelihood that a  bank holding company will fail and the likelihood it will be rescued if it  fails—but we cannot precisely identify the influence of each factor with  certainty.
Why GAO Did This Study

This testimony summarizes the information contained in GAO's Month Year report, entitled Large Bank Holding Companies: Expectations of Government Support, GAO-14-621 .

What GAO Found

While views varied among market participants with whom GAO spoke, many believed that recent regulatory reforms have reduced but not eliminated the likelihood the federal government would prevent the failure of one of the largest bank holding companies. Recent reforms provide regulators with new authority to resolve a large failing bank holding company in an orderly process and require the largest bank holding companies to meet stricter capital and other standards, increasing costs and reducing risks for these firms. In response to reforms, two of three major rating agencies reduced or removed the assumed government support they incorporated into some large bank holding companies’ overall credit ratings. Credit rating agencies and large investors cited the new Orderly Liquidation Authority as a key factor influencing their views. While several large investors viewed the resolution process as credible, others cited potential challenges, such as the risk that multiple failures of large firms could destabilize markets. Remaining market expectations of government support can benefit large bank holding companies if they affect investors’ and customers’ decisions.
GAO analyzed the relationship between a bank holding company’s size and its funding costs, taking into account a broad set of other factors that can influence funding costs. To inform this analysis and to understand the breadth of methodological approaches and results, GAO reviewed selected studies that estimated funding cost differences between large and small financial institutions that could be associated with the perception that some institutions are too big to fail. Studies GAO reviewed generally found that the largest financial institutions had lower funding costs during the 2007-2009 financial crisis but that the difference between the funding costs of the largest and smaller institutions has since declined. However, these empirical analyses contain a number of limitations that could reduce their validity or applicability to U.S. bank holding companies. For example, some studies used credit ratings which provide only an indirect measure of funding costs.
GAO’s analysis, which addresses some limitations of these studies, suggests that large bank holding companies had lower funding costs than smaller ones during the financial crisis but provides mixed evidence of such advantages in recent years. However, most models suggest that such advantages may have declined or reversed. GAO developed a series of statistical models that estimate the relationship between bank holding companies’ bond funding costs and their size or systemic importance, controlling for other drivers of bond funding costs, such as bank holding company credit risk. Key features of GAO’s approach include the following:
• U.S. Bank Holding Companies: The models focused on U.S. bank holding companies to better understand the relationship between funding costs and size in the context of the U.S. economic and regulatory environment.
• Bond Funding Costs: The models used bond yield spreads—the difference between the yield or rate of return on a bond and the yield on a Treasury bond of comparable maturity—to measure funding costs because they are a risk-sensitive measure of what investors charge bank holding companies to borrow.