A Macroeconomic Model with Heterogeneous Banks

Abstract

I study positively and normatively the role of bank heterogeneity in the macroeconomy. I build an empirically-motivated macroeconomic model with a banking sector that features uninsurable idiosyncratic rate of return shocks, endogenous markups, costly default, and endogenous entry. The framework highlights a trilemma for bank regulation: the government cannot simultaneously improve financial competition, efficiency, and stability. Three validated channels impact the transmission of policy regimes on the macroeconomy: an economies of scale channel from larger banks being more efficient, an endogenous competition channel from larger banks charging higher markups, and a financial stability channel from smaller banks facing shorter distance to default. The trilemma extends to deposit insurance schemes, heterogeneous capital requirements, the too-big-to-fail hazard, and optimal constrained efficient allocations. I discuss implications of the framework for the ongoing rise of banking concentration, emergence of fintech credit, targeted stabilization policies like bank-level bailouts and liquidity facilities, and intermediary asset pricing.