Ring-Fencing, Lending Competition, and Taxpayer Exposure
30 Pages Posted: 25 Nov 2016 Last revised: 2 Sep 2017
Date Written: September 1, 2017
We evaluate the effects of ring-fencing on lending market competition, and thereby on banks' risk-taking as well as taxpayers' risk exposure. We show analytically that strong ring-fencing intensifies lending market competition, reduces bank profits, and increases borrower and consumer surplus compared with weak or no ring-fencing. We find no theoretical support for weak ring-fencing as a successful instrument to induce financial stability. Nevertheless weak ring-fencing induces lower expected bailout costs than strong and no ring-fencing if the probability of a banking crisis is lower than the fraction of total deposits that banks allocate outside of bailout protection under weak ring-fencing.
Keywords: Ring-fencing, separation of retail banking and investment banking, financial crises, bailout of banks, lending market competition
JEL Classification: G21, G28
Suggested Citation: Suggested Citation