Internal and External Capital Markets of Large Banks

Abstract

Despite regulatory restrictions, large U.S. bank holding companies have sizable and
dynamic internal capital markets. They raise long-term debt at the holding company
and deposits at the commercial bank to internally make unsecured loans to affiliated
broker-dealers. This internal borrowing is not at the same arms length as external
borrowing. Internal capital markets respond more and faster to broker-dealer investment
opportunities than external ones. Despite this, the internal capital market is not perfect.
At horizons of less than a quarter, internal capital is slow moving. This friction causes
partial segmentation of liquidity within the bank holding company.

Keywords: Banks, Internal Capital Markets, Frictions, Arbitrage

JEL Classification: G21, G32, G12