Mean Variance Optimization of Non-Linear Systems and Worst-case Analysis



CFS Working Paper No. 2006/08

Bank Mergers, Competition and Liquidity*

Elena Carletti1, Philipp Hartmann2,
and Giancarlo Spagnolo3

March 6, 2006

Forthcoming in the Journal of Money, Credit and Banking

Abstract:

We model the impact of bank mergers on loan competition, reserve holdings and aggregate
liquidity. A merger changes the distribution of liquidity shocks and creates an internal money
market, leading to financial cost efficiencies and more precise estimates of liquidity needs.
The merged banks may increase their reserve holdings through an internalization effect or
decrease them because of a diversification effect. The merger also affects loan market
competition, which in turn modifies the distribution of bank sizes and aggregate liquidity
needs. Mergers among large banks tend to increase aggregate liquidity needs and thus the
public provision of liquidity through monetary operations of the central bank.

JEL Classification: D43, G21, G28, L13

Keywords: Credit Market Competition, Bank Reserves, Internal Money Market, Banking
System Liquidity, Monetary Operations

* We would like to thank Franklin Allen, Giuseppe Bertola, Ulrich Bindseil, Urs Birchler, Jurg Blum, Vittoria Cerasi, Hans Degryse,
Fiorella De Fiore, Mark Flannery (the editor), Charles Goodhart, Martin Hellwig, Cornelia Holthausen, Haizhou Huang, Roman Inderst,
Andreas Irmen, Simone Manganelli, Loretta Mester, Bruno Parigi, Rafael Repullo, Jean-Charles Rochet, Richard Rosen, Martin Ruckes,
Rune Stenbacka, Andy Sturm, Jurgen Weigand for comments and suggestions. Thanks also to participants at a number of seminars and
conferences. We appreciated the excellent research assistance by Andres Manzanares and Sandrine Corvoisier. Any views expressed are
only the authors’ own and do not necessarily coincide with the views of the ECB or the Eurosystem.

1 Center for Financial Studies and Wharton Financial Institutions Center; email: [email protected]

2 European Central Bank, DG Research, and CEPR; email: [email protected]

3 Stockholm School of Economics, Consip Research Unit, and CEPR; email: [email protected]



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