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Depositor behavior and the "too big to fail" effect


The failure of a large financial institution increases the risk of collapse of an entire financial system. Systemic crises have real effects on the economy and may even lead to recessions. For this reason, central banks and other regulators try to develop mechanisms to reduce the likelihood of crises. Still, problems in the banking sector occur with some frequency. In order to avoid facing the costs on the real economy, in many cases, governments bail out large financial institutions, as in 2008 and 2009 in the United States and Europe. These financial institutions are referred to as "too big to fail". However, the financial literature considers that bailing out failing banks increases the economic instability in the long run because it reduces the incentives for creditors to monitor financial institutions, which potentially leads to increased moral hazard. The objective of the proposed research, which builds on a preliminary work by the participants of this project is to empirically investigate if depositors of Brazilian banks behaved as if there was an implicit policy of rescuing large banks during the worst period of the recent global financial crisis, in late 2008. We will work with primary and secondary data to identify if depositor behavior may be attributed to a perception of a too big to fail policy or not, and to check whether different types of depositors (institutional investors, corporations and individuals) respond to changes in bank fundamentals and crisis situations differently. (AU)

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