Crisis-Proofing Heterogeneous Banks

Recent financial crises have exposed the vulnerabilities of heterogeneous banking models, with investment banks facing greater risks than their retail counterparts due to volatile trading portfolios. This study introduces a three-period general equilibrium model that integrates bank heterogeneity with a novel crisis-induced adaptation mechanism, enabling banks to shift toward resilient retail models during economic distress. Unlike traditional frameworks that assume uniform bank behavior or rely on static analyses, this model captures the dynamic structural adjustments that mitigate systemic risk, offering a nuanced perspective on financial stability. Drawing on comprehensive U.S. and European banking data, the framework is validated across diverse shocks, including regional bank failures and global market disruptions. The findings inform regulatory strategies aligned with Basel III principles, addressing the unique challenges of mid-sized banks while tackling emerging risks from fintech innovations and climate exposures. By bridging micro-level bank dynamics with macro-level stability, the study provides a robust tool for regulators navigating the complexities of modern financial systems, with implications for both domestic and global banking landscapes.