U.S. federal financial regulators have made progress in implementing provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) and related reforms to restrict future government support and reduce the likelihood and impacts of the failure of a systemically important financial institution (SIFI). These reforms can be grouped into four general categories: (1) restrictions on regulators' emergency authorities to provide assistance to financial institutions; (2) new tools and authorities for regulators to resolve a failing SIFI outside of bankruptcy if its failure would have serious adverse effects on the U.S. financial system; (3) enhanced regulatory standards for SIFIs related to capital, liquidity, and risk management; and (4) other reforms intended to reduce the potential disruptions to the financial system that could result from a SIFI's failure. 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. Citing recent reforms, two of the three largest credit rating agencies reduced or eliminated "uplift"--an increase in the credit rating--they had assigned to the credit ratings of eight of the largest bank holding companies due to their assumptions of government support for these firms. 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. For example, market beliefs about government support could benefit a firm by lowering its funding costs to the extent that providers of funds--such as depositors, bond investors, and stockholders--rely on credit ratings that assume government support or incorporate their own expectations of government support into their decisions to provide funds. Second, higher credit ratings from assumed government support can benefit firms through private contracts that reference credit ratings such as derivative contracts that tie collateral requirements to a firm's credit rating. Finally, expectations of government support can affect a firm's ability to attract customers to varying degrees. New and higher fees imposed by the Dodd-Frank Act, stricter regulatory standards, and other reforms could increase costs for the largest bank holding companies relative to smaller competitors. Officials from the Financial Stability Oversight Council (FSOC) and its member agencies have stated that financial reforms have not completely removed too-big- to-fail perceptions but have made significant progress toward doing so. According to Department of the Treasury (Treasury) officials, key areas that require continued progress include education of market participants on reforms and international coordination on regulatory reform efforts, such as creating a viable process for resolving a failing financial institution with significant cross-border activities. 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. In addition, studies that pooled a large number of countries in their analysis have results that may not be applicable to U.S. bank holding companies and studies that did not include data past 2011 have results that may not reflect recent changes in the regulatory environment. 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. To conduct our analysis, we developed a series of econometric models-- models that use statistical techniques to estimate the relationships between quantitative economic and financial variables--based on our assessment of relevant studies and expert views. 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. In contrast, some of the literature we reviewed analyzed nonbank financial companies and foreign companies. 2006-2013 time period. To better understand the relationship between bank holding company funding costs and size in the context of the current economic and regulatory environment, we analyzed the period from 2006 through 2013, which includes the recent financial crisis as well as years before the crisis and following the enactment of the Dodd-Frank Act. In contrast, some of the literature we reviewed did not analyze data in the years after the financial crisis. Bond funding costs. 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. This indicator of funding costs has distinct advantages over certain other indicators used in studies we reviewed, including credit ratings, which do not directly measure funding costs, and total interest expense, which mixes the costs of funding from multiple sources. Alternative measures of size. Size or systemic importance can be measured in multiple ways, as reflected in our review of the literature. Based on that review and the comments we received from external reviewers, we used four different measures of size or systemic importance: total assets, total assets and the square of total assets, whether or not a bank holding company was designated a global systemically important bank by the Financial Stability Board in November 2013, and whether or not a bank holding company had assets of $50 billion or more. Extensive controls for bond liquidity, credit risk, and other key factors. To account for the many factors that could influence funding costs, we controlled for credit risk, bond liquidity, and other key factors in our models. We included a number of variables that are associated with the risk of default, including measures of capital adequacy, asset quality, earnings, and volatility. We also included a number of variables that can be used to measure bond liquidity. Finally, we included variables that measure other key characteristics of bonds, such as time to maturity, and key characteristics of bank holding companies, such as operating expenses. Our models include a broader set of controls for credit risk and bond liquidity than some studies we reviewed and we directly assess the sensitivity of our results to using alternative controls on our estimates of funding costs. Multiple model specifications. In order to assess the sensitivity of our results to using alternative measures of size, bond liquidity, and credit risk, we estimated multiple different model specifications. We developed models using four alternative measures of size, two alternative sets of measures of capital adequacy, six alternative measures of volatility, and three alternative measures of bond liquidity. In contrast, some of the studies we reviewed estimated a more limited number of model specifications. Link between size and credit risk. To account for the possibility that investors' beliefs about government rescues affect their responsiveness to credit risk, our models allow the relationships between bank holding company funding costs and credit risk to depend on size. Altogether, we estimated 42 different models for each year from 2006 through 2013 and then used those models to compare bond yield spreads--our measure of bond funding costs--for bank holding companies of different sizes but with the same level of credit risk. Figure 1 shows our models' comparisons of bond funding costs for bank holding companies with $1 trillion in assets and average credit risk and bond funding costs for similar bank holding companies with $10 billion in assets, for each model and for each year. Each circle and dash in figure 1 shows the comparison for a different model. Circles show model- estimated differences that were statistically significant at the 10 percent level, while dashes represent differences that were not statistically significant at that level. Circles and dashes below zero correspond to models suggesting that bank holding companies with $1 trillion in assets have lower bond funding costs than bank holding companies with $10 billion in assets, and vice versa. For example, for 2013, a total of 18 models predicted statistically significant differences above zero and a total of eight models predicted statistically significant differences below zero. Our analysis provides evidence that the largest bank holding companies had lower funding costs during the 2007-2009 financial crisis but that these differences may have declined or reversed in recent years. However, we found that the outcomes of our econometric models varied with the various controls we used to capture size, credit risk, and bond liquidity. This variation indicates that uncertainty related to how to model funding costs has an important impact on estimated funding cost differences between large and small bank holding companies. As figure 1 shows, most models found that larger bank holding companies had lower bond funding costs than smaller bank holding companies during the 2007-2009 financial crisis, but the magnitude of the difference varied widely across models, as indicated by the range of results for each year. For example, for 2008, our models suggest that bond funding costs for bank holding companies with $1 trillion in assets and average credit risk were from 17 to 630 basis points lower than bond funding costs for similar bank holding companies with $10 billion in assets. Our models' comparisons of bond funding costs for different-sized bank holding companies for 2010 through 2013 also vary widely. For bank holding companies with average credit risk, more than half of our models suggest that larger bank holding companies had higher bond funding costs than smaller bank holding companies from 2011 through 2013, but many models suggest that larger bank holding companies still had lower bond funding costs than smaller ones during this period. For example, for 2013, our models suggest that bond funding costs for average credit risk bank holding companies with $1 trillion in assets ranged from 196 basis points lower to 63 basis points higher than bond funding costs for similar bank holding companies with $10 billion in assets (see fig. 1). For 2013, 30 of our models suggest that the larger banks had higher funding costs, and 12 of our models suggest that the larger banks had lower funding costs. To assess how investors' beliefs that the government will support failing bank holding companies have changed over time, we compared bond funding costs for bank holding companies of various sizes while holding the level of credit risk constant over time at the average for 2008--a relatively high level of credit risk that prevailed during the financial crisis. In these hypothetical scenarios, most models suggest that bond funding costs for larger bank holding companies would have been lower than bond funding costs for smaller bank holding companies in most years from 2010 to 2013. For example, most models for 2013 predict that bond funding costs for larger bank holding companies would be higher than for smaller bank holding companies at the average level of credit risk in that year, but would be lower at financial crisis levels of credit risk (see fig. 2). These results suggest that changes over time in funding cost differences we estimated (depicted in fig. 1) have been driven at least in part by improvements in the financial condition of bank holding companies. At the same time, more models predict lower bond funding costs for larger bank holding companies in 2008 than in 2013 when we assume that financial crisis levels of credit risk prevailed in both years, which suggests that investors' expectations of government support have changed over time. However, it is important to note that the relationships between variables estimated by our models could be sensitive to the average level of credit risk among bank holding companies, making these estimates of the potential impact of the level of credit risk from 2008 in the current environment even more uncertain. Moreover, Dodd-Frank Act reforms discussed earlier in this statement, such as enhanced regulatory standards for capital and liquidity, could enhance the stability of the U.S. financial system and make such a credit risk scenario less likely. This analysis builds on certain aspects of prior studies, but our estimates of the relationship between the size of a bank holding company and the yield spreads on its bonds are limited by several factors and should be interpreted with caution. Our estimates of differences in funding costs reflect a combination of several factors, including investors' beliefs about the likelihood that a bank holding company will fail, the likelihood that it will be rescued by the government if it fails, and the size of the losses that the government may impose on investors if it rescues the bank holding company. Like the methodologies used in the literature we reviewed, our methodology does not allow us to precisely identify the influence of each of these components. As a result, changes over time in our estimates of the relationship between bond funding costs and size may reflect changes in one or more of these components, but we cannot identify which with certainty. In addition, these estimates may reflect factors other than investors' beliefs about the likelihood of government support and may also reflect differences in the characteristics of bank holding companies that do and do not issue bonds. If a factor that we have not taken into account is associated with size, then our results may reflect the relationship between bond funding costs and this omitted factor instead of, or in addition to, the relationship between bond funding costs and bank holding company size. Finally, our estimates are not indicative of future trends. After reviewing the draft report, Treasury provided general comments and Treasury, FDIC, the Federal Reserve Board, and OCC provided technical comments. In its written comments, Treasury commented that our draft report represents a meaningful contribution to the literature and that our results reflect increased market recognition that the Dodd-Frank Act ended "too big to fail" as a matter of law. While our results do suggest bond funding cost differences between large and smaller bank holding companies may have declined or reversed since the 2007-2009 financial crisis, we also found that a higher credit risk environment could be associated with lower bond funding costs for large bank holding companies than for small ones. 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. In addition, Treasury and other agencies provided via email technical comments related to the draft report's analysis of funding cost differences between large and small bank holding companies. We incorporated these comments into the report, as appropriate. A complete discussion of the agencies' comments and our evaluation are provided in the report. Chairman Brown, Ranking Member Toomey, and Members of the Subcommittee, this concludes my prepared remarks. I would be happy to answer any questions that you or other Members of the Subcommittee may have. For future contacts regarding this statement, please contact Lawrance L. Evans, Jr. at (202) 512-4802 or at evansl@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this statement. Other GAO staff who made significant contributions to this statement and the report it is based on include: Karen Tremba, Assistant Director; John Fisher (Analyst-in-Charge); Bethany Benitez; Michael Hoffman; Risto Laboski; Courtney LaFountain; Rob Letzler; Marc Molino; Jason Wildhagen; and Jennifer Schwartz. Other assistance was provided by Abigail Brown; Rudy Chatlos; Stephanie Cheng; and Jose R. Pena. This is a work of the U.S. government and is not subject to copyright protection in the United States. The published product may be reproduced and distributed in its entirety without further permission from GAO. However, because this work may contain copyrighted images or other material, permission from the copyright holder may be necessary if you wish to reproduce this material separately.

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