Abstract
The goal of this paper is to provide a framework to analyze the effectiveness of bank coalition formation in response to an external aggregate shock that may cause disruption to the payment mechanism and real economic activity. I show that the kind of insurance mechanism provided by a specific type of bank coalition allows society to completely prevent any disruption to real activity that can be caused by a temporary drop in the 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 private bank coalition will be unable to completely prevent a disruption in real activity even though it will be able to substantially mitigate the effects on equilibrium quantities and prices. Thus, the existence of a private bank coalition of the kind described in this paper can be an effective means of preventing significant disruptions in trading activity.
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