Working Paper: NBER ID: w24132
Authors: Eduardo Dvila; Ansgar Walther
Abstract: We explore how large and small banks make funding decisions when the government provides system-wide bailouts to the financial sector. We show that bank size, purely on strategic grounds, is a key determinant of banks' leverage choices, even when bailout policies treat large and small banks symmetrically. Large banks always take on more leverage than small banks because they internalize that their decisions directly affect the government's optimal bailout policy. In equilibrium, small banks also choose strictly higher borrowing when large banks are present, since banks' leverage choices are strategic complements. Overall, the presence of large banks increases aggregate leverage and the magnitude of bailouts. The optimal ex-ante regulation features size-dependent policies that disproportionally restrict the leverage choices of large banks. A quantitative assessment of our model implies that an increase in the share of assets held by the five largest banks from 50% to 70% is associated with a 3.5 percentage point increase in aggregate debt-to-asset ratios (from 90.1% to 93.6%). Under the optimal policy, large banks face a “size tax” of 40 basis points (0.4%) per dollar of debt issued.
Keywords: No keywords provided
JEL Codes: E61; G21; G28
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Large banks' leverage decisions (G21) | Government responses (H12) |
| Presence of large banks (G21) | Small banks' leverage increase (G21) |
| Large banks' leverage decisions (G21) | Aggregate leverage (E51) |
| Large banks' leverage decisions (G21) | Small banks' risk-taking behavior (G21) |
| Concentration of large banks (G21) | Leverage ratios (G32) |