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Regulating Financial Conglomerates

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Author Info
Xavier Freixas () (Universitat Pompeu Fabra, CEPR)
Gyongyi Loranth (London Business School)
Alan D. Morrison () (University of Oxford, Saïd Business School)
Hyun Song Shin () (London School of Economics, CEPR)

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Abstract

We analyse a model of financial intermediation in which intermediaries are subject to moral hazard and they do not invest socially optimally, because they ignore the systemic costs of failure and, in the case of banks, because they fail to account for risks which are assumed by the deposit insurance fund. Capital adequacy requirements are designed to minimise the social costs of these effects. We show that banks should always have higher regulatory capital requirements than insurance companies. Contrary to received wisdom, when banks and insurance companies combine to form financial conglomerates we show that it is socially optimal to separate their balance sheets. Moreover, the practice of "regulatory arbitrage", or of transfering assets from one balance sheet to another, is welfare increasing.

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Paper provided by National Bank of Belgium in its series Research series with number 200405-10.

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Length: 25 pages
Date of creation: May 2004
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Handle: RePEc:nbb:reswpp:200405-10

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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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  4. Bernard Shull & Lawrence J. White, 1998. "Of firewalls and subsidiaries: the right stuff for expanded bank activities," Proceedings, Federal Reserve Bank of Chicago, issue May, pages 509-530.
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  16. Patrick Bolton & Xavier Freixas, 2000. "Equity, Bonds, and Bank Debt: Capital Structure and Financial Market Equilibrium under Asymmetric Information," Journal of Political Economy, University of Chicago Press, vol. 108(2), pages 324-351, April. [Downloadable!] (restricted)
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  23. Alain Nyssens & Paul Butzen & Patrick Bisciari, 2000. "Performances économiques des Etats-Unis dans les années nonante," Documents series 200003-3, National Bank of Belgium. [Downloadable!]
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  24. Michele Cincera, 2002. "Financing constraints, fixed capital and R&D investment decisions of belgian firms," Research series 200205-13, National Bank of Belgium. [Downloadable!]
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  25. Frank Dierick, 2004. "The supervision of mixed financial services groups in Europe," Occasional Paper Series 20, European Central Bank. [Downloadable!]
  26. Lóránth, Gyöngyi & Morrison, Alan, 2003. "Multinational Bank Regulation with Deposit Insurance and Diversification Effects," CEPR Discussion Papers 4148, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
  27. Philippe Jeanfils, 2001. "A guided tour of the world of rational expectations models and optimal policies," Research series 2001-06, National Bank of Belgium. [Downloadable!]
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  28. Mälkönen , Ville, 2004. "Capital adequacy regulation and financial conglomerates," Research Discussion Papers 10/2004, Bank of Finland. [Downloadable!]
  29. Paul Butzen & Catherine Fuss & Philip Vermeulen, 2002. "The impact of uncertainty on investment plans," Research series 200205-5, National Bank of Belgium. [Downloadable!]
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Holopainen, Helena, 2007. "Integration of financial supervision," Research Discussion Papers 12/2007, Bank of Finland. [Downloadable!]
  2. Lóránth, Gyöngyi & Morrison, Alan, 2008. "Bank Diversification and Incentives," CEPR Discussion Papers 7051, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
  3. Olivier De Jonghe, 2009. "Back to the basics in banking ? A micro-analysis of banking system stability," Research series 200906-26, National Bank of Belgium. [Downloadable!]
    Other versions:
  4. Wagner, Wolf, 2006. "The broadening of activities in the financial system : implications for financial stability and regulation," Discussion Paper 72, Tilburg University, Center for Economic Research. [Downloadable!]
  5. Thomas Harr & Thomas Rønde, 2006. "Regulation of Banking Groups," FRU Working Papers 2006/01, University of Copenhagen. Department of Economics. Finance Research Unit. [Downloadable!]
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