Banking and Markets

Posted: 22 Jan 2002

See all articles by Franklin Allen

Franklin Allen

Imperial College London

Douglas M. Gale

New York University (NYU) - Department of Economics


A complex financial system comprises both financial markets and financial institutions. Financial institutions can take the form of intermediaries or banks. Bank-based financial systems unlike intermediary-based systems, are subject to crises, but crises do not imply market failure. We show that a sophisticated financial system - a system with complete markets for aggregate risk and limited market participation - is incentive-efficient, if the institutions take the form of intermediaries, or else constrained-efficient, if they take the form of banks. We also consider an economy in which the markets for aggregate risks are incomplete. In this context, there is a role for prudential regulation: regulating liquidity can improve welfare.

Suggested Citation

Allen, Franklin and Gale, Douglas M., Banking and Markets. Available at SSRN:

Franklin Allen (Contact Author)

Imperial College London ( email )

South Kensington Campus
Exhibition Road
London, Greater London SW7 2AZ
United Kingdom

Douglas M. Gale

New York University (NYU) - Department of Economics ( email )

269 Mercer Street, 7th Floor
New York, NY 10011
United States
(212) 998-8944 (Phone)
(212) 995-3932 (Fax)

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