A Bundling Argument for Narrow Banking

33 Pages Posted: 2 Jul 2016

See all articles by Oz Shy

Oz Shy

Federal Reserve Banks - Federal Reserve Bank of Atlanta

Rune Stenbacka

Hanken School of Economics

Date Written: June 19, 2000

Abstract

This study demonstrates a substantial inefficiency in the banking industry resulting from allowing banks to maintain less than a one-hundred percent reserve requirement, thereby exposing depositors to unwanted risks such as investment risks as well as bank runs and bank crises (e.g., the crisis of Scandinavian banks during the early 1990s, and the S&L in the US during the 1980s). This distortion occurs since depositors with uncertain liquidity needs are unable to find riskless no-return banks who will store their money and perform other basic services (ATM, electronic transfers, checkbooks, and bill payment) by charging nominal fees without exposing depositors to any risk. Thus, it is demonstrated that a substantial welfare loss occurs when profit-maximizing banks bundle deposits accounts with risk taking. We further demonstrate that with the rapid development of securities markets a narrow-banking policy will expand consumers' saving/investment opportunities despite the lending restrictions imposed on the banks. Finally, we demonstrate that deposit insurance policies do not eliminate this inefficiency.

Keywords: Narrow Banking, Deposit Insurance, Bank Crises

JEL Classification: G21, G28

Suggested Citation

Shy, Oz and Stenbacka, Rune, A Bundling Argument for Narrow Banking (June 19, 2000). Available at SSRN: https://ssrn.com/abstract=2803179 or http://dx.doi.org/10.2139/ssrn.2803179

Oz Shy (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of Atlanta ( email )

1000 Peachtree Street N.E.
Atlanta, GA 30309-4470
United States

HOME PAGE: http://www.frbatlanta.org/research/economists/shy-oz.aspx?panel=1

Rune Stenbacka

Hanken School of Economics ( email )

P.O. Box 479
Arkadiankatu 22
Helsinki, Helsinki 00101
Finland

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