The impact of a systemic tax on bank capital holdings, optimal capital requirements and social welfare

Existing studies suggest levying a systemic risk tax on systemically important banks to cover the costs of governmental interventions in (bailing out) these banks in the case of their bankruptcies. We develop a static model to investigate how this tax would affect the banks' equilibrium capital holdings and its impacts on banks’ optimal capital regulations in terms of social welfare. We find that this tax would not only result in a safer banking system but would also help to mitigate the pro-cyclical effects of banking capital requirements. However, these merits would come at the cost of an increase in loan rate. Moreover, the improvements of the tax are less pronounced when the capital requirements are relatively strict as, for example, in Basel III. Regarding welfare, Basel II is closer to the optimal level. Although Basel III results in a safer banking system, this improvement compromises social welfare. Our findings also suggest that regulators should set higher capital requirements for systemically important banks, which is similar to the rules in Basel III.