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Banking and Trading

Arnoud Boot () and Lev Ratnovski ()

No 12/238, IMF Working Papers from International Monetary Fund

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, shortterm, capital constrained, and with the ability to generate risk from concentrated positions. When a bank engages in trading, it can use its ‘spare’ capital to profitablity 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 deepending of the 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.

Keywords: Capital; Banking; Bank regulations; Commercial banks; Resource allocation; Investment; Bank regulation, proprietary trading, relationship banking, Volcker rule, moral hazard, financial markets, bank profits, bank profitability, Government Policy and Regulation, (search for similar items in EconPapers)
Pages: 48
Date: 2012-10-02
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Journal Article: Banking and Trading (2016) Downloads
Working Paper: Banking and Trading (2012) Downloads
Working Paper: Banking and Trading (2012) Downloads
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