Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/87224 
Year of Publication: 
2012
Series/Report no.: 
Tinbergen Institute Discussion Paper No. 12-107/IV/DSF42
Publisher: 
Tinbergen Institute, Amsterdam and Rotterdam
Abstract: 
We study the effects of a bank’s engagement in trading. Traditional banking is relationship-based: not scalable, long-term oriented, with high implicit capital, and low risk (thanks to the law of large numbers). Trading is transactions-based: scalable, short-term, capital constrained, and with the ability to generate risk fromconcentrated positions. When a bank engages in trading, it can use its 'spare' capital to profitably expand the scale of trading. However there are two inefficiencies.A bank may allocate too much capital to trading ex-post, compromising the incentives to build relationships ex-ante. And a bank may use trading for risk-shifting.Financial development augments the scalability of trading, which initially benefits conglomeration, but beyond some point inefficiencies dominate. The deepening of financial markets in recent decades leads trading in banks to become increasingly risky, so that problems in managing and regulating trading in banks will persist for the foreseeable future. The analysis has implications for capital regulation, subsidiarization, and scope and scale restrictions in banking.
Subjects: 
Banks
Depository Institutions
Micro Finance Institutions
Mortgages
Investment Banking
Venture Capital
Brokerage
Ratings and Ratings Agencies
Government Policy and Regulation
JEL: 
G21
G24
G28
Document Type: 
Working Paper

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