The impact of bank size, capital strucgture and asset dependence on social welfare

We investigate how social welfare is jointly affected by bank size, banks’ capital structure, and asset dependence across banks. The model suggests that banks always prefer a capital ratio below the socially optimal level, while banks prefer an extra large size when cross-sectional dependencies are typically low. More stringent capital requirements result in larger banks under low bankruptcy
costs, high financing costs and high taxes. To enhance social welfare, policies on capital are nevertheless more effective than policies on size. This is particularly true when dependencies are low, i.e., during economic booms. Our results are in support of the countercyclical capital buffers in the Basel III proposals and imply a negative association between the stringency of monetary policy and prudential policy.