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Does size matter? : Bailouts with large and small banks

Author: Eduardo Dávila; Ansgar Walther; National Bureau of Economic Research,
Publisher: Cambridge, Mass. : National Bureau of Economic Research, 2017.
Series: Working paper series (National Bureau of Economic Research), no. 24132.
Edition/Format:   eBook : Document : EnglishView all editions and formats
Summary:
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  Read more...
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Material Type: Document, Internet resource
Document Type: Internet Resource, Computer File
All Authors / Contributors: Eduardo Dávila; Ansgar Walther; National Bureau of Economic Research,
OCLC Number: 1018416421
Notes: "December 2017"
Description: 1 online resource (54 pages) : illustrations.
Series Title: Working paper series (National Bureau of Economic Research), no. 24132.
Responsibility: 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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