Does Size Matter? Bailouts with Large and Small Banks
نویسنده
چکیده
Yes, size actually matters. This paper models the strategic interaction between banks and the government when bailouts are possible. I analyze how imperfect common knowledge about the government’s bailout policy affects the ex-ante leverage choice for each bank. Large banks, by internalizing the effect of their size on the likelihood of being bailed out, are willing to take more leverage. In equilibrium, the existence of these large entities induces small banks to also increase their leverage. Therefore, the probability of bailout and the economy-wide leverage is larger when large banks are present. Regulators should treat large banks differently. JEL numbers: E61, G01, G21, G28
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