The optimal level of risk taken by TBTF banks from a private perspective can be higher than the socially eﬃcient level of risk: Owners of banks fully reap potential proﬁts but only partially bear potential risks due to the expected government bailout in case of distress.
Excessive risk-taking implies costs for society: If risks materialize, taxpayers may face additional costs related to the need to rescue the bank. Regulatory reforms aimed at internalizing the external costs through, for example, higher loss absorbing capacity and provisions to facilitate the orderly resolution of TBTF banks thus have the potential to increase social welfare.