A Theory of the Boundaries of Banks With Implications for Financial Integration and Regulation

Falko Fecht; Roman Inderst; Sebastian Pfeil

doi:10.1111/fima.70002

A Theory of the Boundaries of Banks With Implications for Financial Integration and Regulation

Falko Fecht
, Roman Inderst
, Sebastian Pfeil^*

^*Corresponding author for this work

Economics, Econometrics and Finance

Research output: Contribution to journal › Article › Academic › peer-review

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Abstract

We offer a theory of the “boundary of the firm” that is tailored to banks, recognizing the relevance of deposit financing and interbank lending as a substitute for integration. It is based on a single inefficiency that has been at the core of banking theory: risk-shifting incentives in the interest of bank shareholders. We explain why deeper economic integration should also cause greater, albeit incomplete, financial integration through both bank mergers and interbank lending. Despite its simplicity, the model can help understand several significant historical trends in the US banking industry.

Original language	English
Journal	Financial Management
DOIs	https://doi.org/10.1111/fima.70002
Publication status	E-pub ahead of print - 13-Aug-2025

Keywords

debt overhang
integration
interbank lending
risk shifting

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abstract = "We offer a theory of the “boundary of the firm” that is tailored to banks, recognizing the relevance of deposit financing and interbank lending as a substitute for integration. It is based on a single inefficiency that has been at the core of banking theory: risk-shifting incentives in the interest of bank shareholders. We explain why deeper economic integration should also cause greater, albeit incomplete, financial integration through both bank mergers and interbank lending. Despite its simplicity, the model can help understand several significant historical trends in the US banking industry.",

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A Theory of the Boundaries of Banks With Implications for Financial Integration and Regulation

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