A Review of Bank Funding Cost Differentials

The debate over the existence and extent of funding cost differentials between large and small banks is central to regulatory reforms related to perceptions of “too big to fail” government support. After providing a simple taxonomy of five basic approaches into which the wide-ranging empirical literature on this topic can be categorized, I analyze key challenges that all of the approaches face, namely, the interpretation of funding costs differences between large and small banks, the choice of the relevant time period, the choice of the sample, and the significant differences in the funding structures of large and small banks. After analyzing further more specific challenges for three of the approaches, I describe the most promising methods for measuring funding cost differentials and present a “natural experiment” concerning the elimination of complete FDIC coverage of transactions deposits at the end of 2012, which suggests that depositors did not perceived a significant difference in risk between large and small banks during this period.