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Regulating Financial Conglomerates

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Author Info
Xavier Freixas
Gyöngyi Lóránth
Alan D. Morrison

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Abstract

We investigate the optimal regulation of financial conglomerates which combine a bank and a non-bank financial institution. The conglomerate’s risk-taking incentives depend upon the level of market discipline it faces, which in turn is determined by the conglomerate’s liability structure. We examine optimal capital requirements for standalone institutions, for integrated financial conglomerates, and for financial conglomerates that are structured as holding companies. For a given risk profile, integrated conglomerates have a lower probability of failure than either their standalone or decentralised equivalent. However, when risk profiles are endogenously selected conglomeration may extend the reach of the deposit insurance safety net and hence provide incentives for increased risk-taking. As a result, integrated conglomerates may optimally attract higher capital requirements. In contrast, decentralised conglomerates are able to hold assets in the socially most efficient place. Their optimal capital requirements encourage this. Hence, the practice of "regulatory arbitrage", or of transferring assets from one balance sheet to another, is welfare-increasing. We discuss the policy implications of our finding in the context not only of the present debate on the regulation of financial conglomerates but also in the light of existing US bank holding company regulation.

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Paper provided by Oxford Financial Research Centre in its series OFRC Working Papers Series with number 2005fe03.

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Date of creation: 2005
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Handle: RePEc:sbs:wpsefe:2005fe03

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Find related papers by JEL classification:
G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Mortgages
G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies
G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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References listed on IDEAS
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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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. 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!]
  3. 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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