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Efficient or systemic banks: Can regulation strike a deal?

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  • Goel, Tirupam

Abstract

Should there be few large or several small banks? Large banks benefit from scale economies, but their default can be systemic. This paper develops a macroeconomic model with heterogeneous banks to study the efficiency versus financial-stability trade-off. Scale economies and default losses are calibrated using micro-data. Unlike representative bank models, a novel banking-dynamics channel of regulation emerges – the endogenous response in banks' size-distribution matters for welfare. Capital regulation that equalizes leverage, default rate, or expected loss across banks fails to account for the size-dependent trade-off. Optimal regulation is size-dependent, features a hump-shaped welfare response, and induces more medium-sized banks.

Suggested Citation

  • Goel, Tirupam, 2025. "Efficient or systemic banks: Can regulation strike a deal?," Journal of Economic Dynamics and Control, Elsevier, vol. 179(C).
    • Handle: RePEc:eee:dyncon:v:179:y:2025:i:c:s0165188925001484
    DOI: 10.1016/j.jedc.2025.105182
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    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • L11 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Production, Pricing, and Market Structure; Size Distribution of Firms
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • C60 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - General

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