This paper analyses contingent-claims based measures of distance to default (D2D) for the 41 largest global banking institutions over the period 2006H2 to 20011H2. D2D falls from end-2006 through to end-2008. Cross-sectional differences in D2D prior to the crisis do not predict either bank failure or bank share prices decline, but D2D measured in mid-2008 does have some predictive value for failure by end-year. The ‘option value’ of the bank safety net remains small except at the height of the crisis and there is little indication of bank shareholders consciously using the safety net to shift risk onto taxpayers.

Building an unbalanced panel of United States (US) bank holding company (BHC) and commercial bank balance-sheet data from 1986 to 2008, we examine the relationship between short-term capital buffer and portfolio risk adjustments. Our estimations indicate that the relationship over the sample period is a positive two-way relationship. Moreover, we show that the management of such adjustments is dependent on the degree of bank capitalization. Further investigation through time-varying analysis reveals a cyclical pattern in the uncovered relationship: negative after the 1991/1992 crisis, and positive before 1991 and after 1997.