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Discussion Paper Details

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Title: A Theory of the Boundaries of Banks with Implications for Financial Integration and Regulation

Author(s): Falko Fecht, Roman Inderst and Sebastian Pfeil

Publication Date: January 2022

Keyword(s): Debt overhang, deposit insurance, integration, Interbank lending and risk shifting

Programme Area(s): Financial Economics and Industrial Organization

Abstract: We offer a theory of the "boundary of the firm" tailored to banks as it builds on a single risk-shifting inefficiency and takes into account interbank lending, as an alternative to integration, and insured deposit financing. It explains why deeper economic integration should cause also greater, though still incomplete, financial integration, through both bank mergers and interbank lending, and why economic disintegration, as currently witnessed in the European Union, should cause less interbank exposure. Recent policy measures such as the preferential treatment of retail deposits, the extension of deposit insurance, or penalties on "connectedness" could reduce welfare.

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Bibliographic Reference

Fecht, F, Inderst, R and Pfeil, S. 2022. 'A Theory of the Boundaries of Banks with Implications for Financial Integration and Regulation'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=16880