DP16880 A Theory of the Boundaries of Banks with Implications for Financial Integration and Regulation
|Author(s):||Falko Fecht, Roman Inderst, Sebastian Pfeil|
|Publication Date:||January 2022|
|Keyword(s):||Debt overhang, deposit insurance, integration, Interbank lending, risk shifting|
|JEL(s):||F36, G21, L25|
|Programme Areas:||Financial Economics, Industrial Organization|
|Link to this Page:||cepr.org/active/publications/discussion_papers/dp.php?dpno=16880|
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.