Banking and Trading

October 2, 2012

Preview Citation

Format: Chicago

Arnoud W.A. Boot, and Lev Ratnovski. Banking and Trading, (USA: International Monetary Fund, 2012) accessed November 21, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

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.

Subject: Bank soundness, Banking, Credit, Financial crises, Financial institutions, Financial sector policy and analysis, Lines of credit, Money, Moral hazard, Tax incentives

Keywords: Bank regulation, Bank soundness, Credit, Credit line, Europe, Franchise value, Interest rate, Lines of credit, Moral hazard, Proprietary trading, Relationship banking, Risky trading, Trading activity, Trading opportunity, Trading strategy, Volcker rule, WP

Publication Details

Pages:

48
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2012/238
Stock No:

WPIEA2012238
ISBN:

9781475511215
ISSN:

1018-5941

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