Working Paper: CEPR ID: DP16880
Authors: Falko Fecht; Roman Inderst; Sebastian Pfeil
Abstract: We offer a theory of the "boundary of the firm" tailored to banks as it builds on a single risk-shifting inefficiency and takes into account interbank lending, as an alternative to integration, and insured deposit financing. It explains why deeper economic integration should cause also greater, though still incomplete, financial integration, through both bank mergers and interbank lending, and why economic disintegration, as currently witnessed in the European Union, should cause less interbank exposure. Recent policy measures such as the preferential treatment of retail deposits, the extension of deposit insurance, or penalties on "connectedness" could reduce welfare.
Keywords: interbank lending; risk shifting; debt overhang; integration; deposit insurance
JEL Codes: G21; F36; L25
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Economic integration (F15) | Greater interbank lending (F65) |
| Economic integration (F15) | Bank mergers (G21) |
| Less economic integration (F69) | Reduced interbank exposure (F65) |
| Economic disintegration (F02) | Reduced allocative efficiency (D61) |
| Interbank lending is more substantial when local lending markets are closely aligned (F65) | Enhanced resource allocation efficiency (D61) |
| Regulatory measures (deposit insurance extensions) (G28) | Reduced financial integration (F65) |