Appendix
Proof of Proposition 1
Using Leibniz’s rule and (1), from (9) we obtain the first order conditions with respect to
the choice variables rL and Ri :
i
∂ Πi
∂ rL
= Li + (riL
_ '∣∂Li
c) ∂rL
rI L2 + 2LjRi rD
2 (Li + Ri)2 + 2
~Lj= = 0, for i = 1...N,
(13)
∂Π
--i = rD(Li + Ri)2 - rIl2 = 0, for i = 1...N. (14)
Solving (14) for Ri gives
(15)
Solving (13) for riL in a symmetric equilibrium where riL = rsLq for i = 1...N after substituting
(2) and (15) gives
l + (rLq - c - √rIrD)(—YN---1 ) = 0,
from which rsLq and csq follow. Substituting then rsLq in (2) gives Lsq, and through (15) Rsq.
Substituting Rsq and Lsq in (1), we obtain Dsq. Q.E.D.
Proof of Corollary 1
Solving (3) and (4) gives φi = 1 — DRi and ωi = (R) Ri + Di. Substituting the expressions
for Rsq and Dsq, we obtain φsq and ωsq as in the corollary. Q.E.D.
Proof of Lemma 1
We proceed in two steps. First, we show that the variance of the liquidity demand xm of
the merged banks is minimized when deposits are raised symmetrically in the two regions.
Second, we show that the expected liquidity needs of the merged banks (and therefore their
refinancing costs) are lower when deposits are symmetric.
Step 1. Define the liquidity demand of the merged banks as
xm = δ1αDm + δ2(1 - α)Dm,
where α ∈ [0, 1] indicates the fraction of deposits that the merged banks raise in one region
and (1 - α) the fraction they raise in the other region. Since δ1 and δ2 are independent and
V ar(δ1) = V ar(δ2), the variance of xm is simply
Var(xm)=α2Dm2 Var(δ1)+(1- α)2Dm2 V ar(δ2)
= V ar(δ1)[α2Dm2 +(1- α)2Dm2 ].
29