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Does Size Matter? Bailouts with Large and Small Banks

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  • Eduardo Dávila
  • 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.

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  • Eduardo Dávila & Ansgar Walther, 2017. "Does Size Matter? Bailouts with Large and Small Banks," NBER Working Papers 24132, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:24132
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    2. Suarez, Javier & Sánchez Serrano, Antonio, 2018. "Approaching non-performing loans from a macroprudential angle," Report of the Advisory Scientific Committee 7, European Systemic Risk Board.
    3. Lambrecht, Bart & Tse, Alex, 2019. "Liquidation, bailout, and bail-in: Insolvency resolution mechanisms and bank lending," CEPR Discussion Papers 13734, C.E.P.R. Discussion Papers.
    4. Mücke, Christian & Pelizzon, Loriana & Pezone, Vincenzo & Thakor, Anjan V., 2021. "The carrot and the stick: Bank bailouts and the disciplining role of board appointments," SAFE Working Paper Series 316, Leibniz Institute for Financial Research SAFE.
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    6. Sigurd Galaasen & Rustam Jamilov & Hélène Rey & Ragnar Juelsrud, 2020. "Granular credit risk," Working Paper 2020/15, Norges Bank.
    7. Ma, Chang & Nguyen, Xuan-Hai, 2021. "Too big to fail and optimal regulation," International Review of Economics & Finance, Elsevier, vol. 75(C), pages 747-758.
    8. Dong, Yi & Hou, Qiannan & Ni, Chenkai, 2021. "Implicit government guarantees and credit ratings," Journal of Corporate Finance, Elsevier, vol. 69(C).
    9. Thomas M. Eisenbach & Gregory Phelan, 2018. "Cournot Fire Sales," Department of Economics Working Papers 2018-01, Department of Economics, Williams College.
    10. Levent Altinoglu & Joseph E. Stiglitz, 2020. "Collective Moral Hazard and the Interbank Market," Finance and Economics Discussion Series 2020-098, Board of Governors of the Federal Reserve System (U.S.).
    11. Wang, Daphne & Jory, Surendranath R. & Ngo, Thanh, 2020. "The cohabitation of institutional investors with the government: A case study of the TARP–CPP program," Journal of Behavioral and Experimental Finance, Elsevier, vol. 28(C).
    12. Lorenc, Amy G. & Zhang, Jeffery Y., 2020. "How bank size relates to the impact of bank stress on the real economy," Journal of Corporate Finance, Elsevier, vol. 62(C).

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    JEL classification:

    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
    • 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

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