Regulating Financial Conglomerates

32 Pages Posted: 13 Sep 2005

See all articles by Xavier Freixas

Xavier Freixas

Universitat Pompeu Fabra; Centre for Economic Policy Research (CEPR); Barcelona Graduate School of Economics (Barcelona GSE)

Gyongyi Loranth

Centre for Economic Policy Research (CEPR)

Alan D. Morrison

University of Oxford - Said Business School; University of Oxford - Merton College

Multiple version iconThere are 4 versions of this paper

Date Written: May 2005

Abstract

We investigate the optimal regulation of financial conglomerates that combine a bank and a non-bank financial institution. The conglomerate's risk-taking incentives depend upon the level of market discipline it faces, which in turn is determined by the conglomerate's liability structure. We examine optimal capital requirements for standalone institutions, for integrated financial conglomerates, and for financial conglomerates that are structured as holding companies. For a given risk profile, integrated conglomerates have a lower probability of failure than either their standalone or decentralized equivalent. However, when risk profiles are endogenously selected conglomeration may extend the reach of the deposit insurance safety net and hence provide incentives for increased risk-taking. As a result, integrated conglomerates may optimally attract higher capital requirements. In contrast, decentralized conglomerates are able to hold assets in the socially most efficient place. Their optimal capital requirements encourage this. Hence, the practice of 'regulatory arbitrage', or of transferring assets from one balance sheet to another, is welfare-increasing. We discuss the policy implications of our finding in the context not only of the present debate on the regulation of financial conglomerates but also in the light of existing US bank holding company regulation.

Keywords: Financial conglomerate, capital regulation, regulatory arbitrage

JEL Classification: G21, G22, G28

Suggested Citation

Freixas, Xavier and Loranth, Gyongyi and Morrison, Alan, Regulating Financial Conglomerates (May 2005). CEPR Discussion Paper No. 5036. Available at SSRN: https://ssrn.com/abstract=774148

Xavier Freixas (Contact Author)

Universitat Pompeu Fabra ( email )

Ramon Trias Fargas 25-27
Barcelona, 08005
Spain
+34 93 542 2726 (Phone)
+34 93 542 1746 (Fax)

HOME PAGE: http://www.econ.upf.es/~freixas

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

HOME PAGE: http://www.econ.upf.es/~freixas/more/personal1.htm

Barcelona Graduate School of Economics (Barcelona GSE) ( email )

Ramon Trias Fargas, 25-27
Barcelona, Barcelona 08005
Spain

Gyongyi Loranth

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Alan Morrison

University of Oxford - Said Business School ( email )

Department of Finance
Park End Street
Oxford OX1 1HP
United Kingdom
+44 18 6527 6343 (Phone)
+44 18 6527 6310 (Fax)

University of Oxford - Merton College

Merton Street
Oxford OX1 4JD
United Kingdom
+44 18 6527 6343 (Phone)

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