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What broad banks do, and markets don't: Cross-subsidization

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  • Koeppl, Thorsten V.
  • MacGee, James C.

Abstract

We show that interbank markets are a poor substitute for "broad" banks that operate across regions or sectors. In the presence of regional or sectoral asset and liquidity shocks, interbank markets can distribute liquidity efficiently, but fail to respond efficiently to asset shocks. Broad banks can condition on the joint distribution of both shocks and, hence, achieve an efficient internal allocation of capital. This allocation involves the cross-subsidization of loans across regions or sectors. Compared to regional banks that are linked through well-functioning interbank markets, broad banks lead to higher levels of aggregate investment, higher output, and less fluctuations within regions. However, broad banks generate endogenously aggregate uncertainty.

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Bibliographic Info

Article provided by Elsevier in its journal European Economic Review.

Volume (Year): 53 (2009)
Issue (Month): 2 (February)
Pages: 222-236

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Handle: RePEc:eee:eecrev:v:53:y:2009:i:2:p:222-236

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Web page: http://www.elsevier.com/locate/eer

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Keywords: Interbank markets Broad banks Endogenous uncertainty Banking restrictions;

References

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Cited by:
  1. Thorsten V. Koeppl & James MacGee, 2007. "Branching Out: The Urgent Need to Transform Canada’s Financial Landscape and How to Do It," C.D. Howe Institute Commentary, C.D. Howe Institute, issue 251, June.

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