Intermediation and Vertical Integration

Competition in retail and wholesale funding markets affect the incentive for originators (like investment bankers) and fund managers (like mutual funds) to form integrated intermediaries (banks). Independent firms integrate both to produce higher yielding, illiquid assets and to suppress competition in retail markets. In addition to the higher return on illiquid assets, three factors increase the incentive to integrate. First, homogeneous savers lower the costs of producing illiquid assets and increase competition in retail markets. Second, fund managers' market power in wholesale markets increases competition in retail markets. Finally, more certain aggregate savings reduces the costs of producing illiquid assets.