Banking and Trading

48 Pages Posted: 28 Sep 2012

See all articles by Arnoud W. A. Boot

Arnoud W. A. Boot

University of Amsterdam - Amsterdam Business School; Centre for Economic Policy Research (CEPR); Tinbergen Institute

Lev Ratnovski

International Monetary Fund

Multiple version iconThere are 3 versions of this paper

Date Written: September 2012

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 from concentrated 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.

Keywords: banking, capital regulation, scale restrictions, trading

JEL Classification: G21, G24, G28, G32

Suggested Citation

Boot, Arnoud W. A. and Ratnovski, Lev, Banking and Trading (September 2012). CEPR Discussion Paper No. DP9148. Available at SSRN: https://ssrn.com/abstract=2153589

Arnoud W. A. Boot (Contact Author)

University of Amsterdam - Amsterdam Business School ( email )

Roetersstraat 11
Amsterdam, 1018 WB
Netherlands
+31 20 525 4162 (Phone)
+31 20 525 5318 (Fax)

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Tinbergen Institute ( email )

Burg. Oudlaan 50
Rotterdam, 3062 PA
Netherlands

Lev Ratnovski

International Monetary Fund ( email )

700 19th Street, N.W.
Washington, DC 20431
United States
+1 202 623 8213 (Phone)

HOME PAGE: http://ratnovski.googlepages.com

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