Efficient or systemic banks: Can regulation strike a deal?

Tirupam Goel

Journal of Economic Dynamics and Control, 2025, vol. 179, issue C

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.

Keywords: Heterogeneous bank model; Size-distribution; Size-dependent policy; G-SIBs; Financial stability; Scale economies (search for similar items in EconPapers)
JEL-codes: C60 E44 G21 G28 L11 (search for similar items in EconPapers)
Date: 2025
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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:179:y:2025:i:c:s0165188925001484

DOI: 10.1016/j.jedc.2025.105182

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