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

  • Thorsten Koeppl

    ()

    (Department of Economics, Queen's University)

  • James MacGee

    ()

    (Department of Economics, University of Western Ontario)

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://qed.econ.queensu.ca/working_papers/papers/qed_wp_1052.pdf
File Function: First version 2005
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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
Date of revision:
Handle: RePEc:qed:wpaper:1052
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