Default, Bailouts and the Vertical Structure of Financial Intermediaries

Should we break up banks and limit bailouts? We study vertical integration of deposit-taking institutions and those investing in risky equity. Integration, by eliminating a credit spread, increases output but entails larger, more frequent bailouts. Bailouts of leveraged institutions boost economic activity but are costly. The optimal structure of intermediaries depends largely on the efficiency of government intervention, the competitiveness of the Önancial sector and shocks hitting the economy. Separated institutions are preferred when profit margins are small, financial shocks systemic and volatile, and bailouts costly. For a baseline calibration, universal banks are typically preferred.