Limits to International Banking Consolidation

Heterogenous banking supervision and regulation is often considered as the most important impediment for Pan-European Bank mergers. In this paper we identify other more fundamental reasons for a limited degree of cross-country integration in retail banking. We argue that the distribution of regional liquidity shocks may pose a natural limit to the extent of cross-border bank mergers. The paper derives the impact of different underlying stochastic structures on the optimal structure of cross regional bank mergers. Imposing a symmetry restriction on the underlying stochastic structure of liquidity shocks we find that benefits from diversification and the costs of contagion may be optimally traded off if banks from some but not from all regions merge. Under an additional monotonicity assumption full integration is only desirable if the number of regions with diverse risks is sufficiently large. We would like to thank the anonymous referee, Marc Flannery, Frank Heid, Michael Koetter, Rowena Pecchenino and the editor, George Tavlas, as well as the conference participants of the 4th INFINITY Conference Dublin for helpful comments. The views expressed here are those of the authors and not necessarily those of the Deutsche Bundesbank.