Are Banks in Switzerland Too-Big-To-Fail?

Abstract: Too-big-to-fail has been a subject of controversy and has gained much attention in the course of the sub-prime financial crisis 2007-2009. Subjects related under this topic for instance are usually about the excessive risk taken by the government, and moral hazard. In this paper, we perform an analysis to examine the existence of too-big-to-fail impact on the banking sector in Switzerland during the financial crisis. By implementing a structural model to value the CDS contracts, and thus compare the model estimates with market observation. Deviation between model estimates and market data indicates the asymmetric expectations between shareholders and creditors. Since government bailout tends to favor creditors, thus the stock-implied model estimates will be less affected. As we expected, overestimation of model predicted CDS spreads are found for banks in Switzerland, where the magnitude differs by government intervention. Our results comply with the theory that under government bailout, the expected default probability diverges between shareholders and creditors, which is a sign of having too-big-to-fail impact.