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What Banks Do and Markets Don't: Cross-subsidization

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Author Info
Thorsten Koeppl () (Department of Economics, Queen's University)
James MacGee () (Department of Economics, University of Western Ontario)

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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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File URL: http://www.econ.queensu.ca/working_papers/papers/qed_wp_1052.pdf
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Publisher Info
Paper provided by Queen's University, Department of Economics in its series Working Papers with number 1052.

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Length: 27 pages
Date of creation: Feb 2005
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Handle: RePEc:qed:wpaper:1052

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Related research
Keywords: Banking Restrictions Interbank Markets Universal Banking Endogenous Uncertainty

Find related papers by JEL classification:
G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Mortgages
G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General
E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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References listed on IDEAS
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