Default, bailouts and the vertical structure of financial intermediaries

Damjanovic, Tatiana; Damjanovic, Vladislav; Nolan, Charles

Abstract

Should we break up banks and limit bailouts? We study vertical integration of deposit-taking institutions with those investing in risky equity. Integration eliminates a credit spread, reducing aggregate banking sector profitability; so while integration increases output it also entails larger, more frequent bailouts of retail customers. Bailouts boost economic activity but are costly. The optimal structure of banking depends on the efficiency of government intervention, the competitiveness of the banking sectors and shocks. Separated institutions are preferred when government bailouts are costly. Optimal bank regulation tolerates profits at investment and universal banks to limit bailouts, but imposes strict antitrust on retail banks.

Citation

Damjanovic, T., Damjanovic, V., & Nolan, C. (2020). Default, bailouts and the vertical structure of financial intermediaries. Review of Economic Dynamics, 38, 154-180. https://doi.org/10.1016/j.red.2020.04.002

• Journal Article Type: Article
• Acceptance Date: Apr 3, 2020
• Online Publication Date: Apr 9, 2020
• Publication Date: Oct 1, 2020
• Deposit Date: Apr 13, 2020
• Publicly Available Date: Oct 9, 2021
• Journal: Review of Economic Dynamics
• Print ISSN: 1094-2025
• Publisher: Elsevier
• Peer Reviewed: Peer Reviewed
• Volume: 38
• Pages: 154-180
• DOI: https://doi.org/10.1016/j.red.2020.04.002
• Public URL: https://durham-repository.worktribe.com/output/1273418