Abstract
The paper evaluates the effects of weak and strong ring-fencing on taxpayers' risk exposure imposed by the banking industry and the consequences for expected consumer welfare (expected depositor surplus plus borrower surplus less bailout taxes). We find no theoretical support for weak ring-fencing as a successful instrument to induce financial stability. Strong ring-fencing intensifies competition in the lending market, reduces equilibrium lending rates and banks' profits, and increases borrower and consumer surplus compared with weak or no ring-fencing. Despite this, the expected bailout costs with weak ring-fencing are lower than the bailout costs associated with no and strong ring-fencing because the loss burden is shifted from taxpayers to depositors.
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