A previous version of this working paper was originally published in July 2013.

He shows that a specific type of bank coalition (a joint-liability arrangement) is an effective arrangement that allows member banks to build a capital buffer that permits them to absorb the effects of an external shock. In particular, it allows society to completely prevent any disruption to trading activity that can be caused by a temporary drop in the aggregate value of banking assets, at least in the case of a shock that is not too big. If the shock is relatively large, then a bank coalition will be unable to completely prevent a disruption in trading activity even though it will be able to substantially mitigate the effects of the shock. Thus, the existence of a private bank coalition of the kind considered in this paper can be an effective means of preventing significant contractions in trading activity.

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