Banking and Trading

Arnoud Boot and Lev Ratnovski ()

No 2012/238, IMF Working Papers from International Monetary Fund

Abstract: We study the effects of a bank's engagement in trading. Traditional banking is relationship-based: not scalable, long-term oriented, with high implicit capital, and low risk (thanks to the law of large numbers). Trading is transactions-based: scalable, shortterm, capital constrained, and with the ability to generate risk from concentrated positions. When a bank engages in trading, it can use its ‘spare’ capital to profitablity expand the scale of trading. However, there are two inefficiencies. A bank may allocate too much capital to trading ex-post, compromising the incentives to build relationships ex-ante. And a bank may use trading for risk-shifting. Financial development augments the scalability of trading, which initially benefits conglomeration, but beyond some point inefficiencies dominate. The deepending of the financial markets in recent decades leads trading in banks to become increasingly risky, so that problems in managing and regulating trading in banks will persist for the foreseeable future. The analysis has implications for capital regulation, subsidiarization, and scope and scale restrictions in banking.

Keywords: WP; credit line; risky trading; interest rate; relationship banking; trading activity; Bank regulation; proprietary trading; Volcker rule; trading strategy; trading opportunity; franchise value; Lines of credit; Moral hazard; Bank soundness; Credit; Europe (search for similar items in EconPapers)
Pages: 48
Date: 2012-10-02
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (32)

Downloads: (external link)
http://www.imf.org/external/pubs/cat/longres.aspx?sk=40031 (application/pdf)

Related works:
Journal Article: Banking and Trading (2016)
Working Paper: Banking and Trading (2012)
Working Paper: Banking and Trading (2012)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:imf:imfwpa:2012/238

Ordering information: This working paper can be ordered from
http://www.imf.org/external/pubs/pubs/ord_info.htm

Access Statistics for this paper

More papers in IMF Working Papers from International Monetary Fund International Monetary Fund, Washington, DC USA. Contact information at EDIRC.
Bibliographic data for series maintained by Akshay Modi ().