[rndmwlk]

Ahh, I see what you're saying now.

First, there's a bit of an assumption of local lending opportunities drying up. This isn't necessarily going to happen, local banks don't have infinite capital, but lets assume that it does happen and consider the scenario you outlined.

I think you are right in that there will be a misalignment of incentives. From the standpoint of long term assets the bank will be holding it will likely be diversified away from exposure to the town. I imagine banks wouldn't be selling off their entire portfolios, and would still have a solid amount of local exposure - but maybe not.

Banking is definitely not risk free! It is multiplying your money supply but doing so through leverage. Back to our scenario to see this effect, what "big bank world" allows there is a step that you missed:

  * regional bank gets local depositors to get cash for lending
  * regional bank can originate loans that they sell off to larger bank
  * larger bank makes long term money off the intrinsics of the loan
  * regional bank made short term money on sale and now has to invest in other long term assets
  * regional bank can originate more loans with short term money on sale
  * regional bank loses all lending opportunities they have locally, so now survive only on long term assets and depositors

So, the tradeoff is really: The town is able to get more local loans, but the bank is able to commoditize away (some) of their risk associated with this town. Is it better for the town to have less capital and a more aligned town bank? It's hard to say.

[taeric]

Thanks for sticking with me on the conversation! Love to see more exploration of this idea. And I would not be shocked/upset to find that I'm asking overly silly questions, or contriving too simple scenarios.