Too-Big-to-Fail: A Study on the Swedish Banking System during the Financial Crisis

Abstract: Too-big-to-fail is a highly debated subject that has gained widespread attention during the latest financial crisis of 2007-2009. Many negative externalities are associated with too-big-to-fail such as excessive risk-taking and overleveraging. In our paper, we present an overview of what too-big-to-fail is and its consequences. In addition, we analyse the effect of too-big-to-fail on the Swedish banking system during the crisis. This analysis is performed by implementing a structural model to value CDS contracts and compare the model spreads to actual market spreads. We find signs of overestimation of CDS spreads for the Swedish banks and the magnitude of the deviations are affected by government intervention during this period. The findings indicate a deviation in default estimations between shareholders and creditors in times of government intervention, which is a sign of too-big-to-fail.