A Theory of the Boundaries of Banks with Implications For Financial Integration and Regulation

Research Area: Financial Stability, Financial Regulation, Financial Markets
Researcher: Falko Fecht,
Roman Inderst,
Sebastian Pfeil
Date: Jan 2015
Abstract:

The authors offer a theory of the "boundary of the firm" that is tailored to banking, as it builds on a single ine¢ ciency arising from risk-shifting and as it takes into account both interbank lending as an alternative to integration and the role of possibly insured deposit funding. Amongst others, it explains both why deeper economic integration should cause also greater Financial integration through both bank mergers and interbank lending, albeit this typically remains ine¢ ciently incomplete, and why economic disintegration (or "desychronization"), as currently witnessed in the European Union, should cause less interbank exposure. It also suggests that recent policy measures such as the preferential treatment of retail deposits, the extension of deposit insurance, or penalties on "connectedness" could all lead to substantial welfare losses.

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